One of the most important things to take from the inflation report is the more positive view on the economy. In Governor Carney’s words, “For the first time in a long time, you don’t have to be an optimist to see the glass as half full. The recovery has taken hold”. Strong economic figures, particularly robust PMI numbers, have encouraged a brighter outlook for UK growth in 2013 and 2014. Consequently, the central bank has raised their forecasts for growth from 1.4% to 1.6% in 2013 and from 2.5% to 2.8% in 2014.
After CPI surprisingly dropped to 2.2%y/y, the BoE now projects inflation will be considerably lower than predicted in August. Although energy price rises are likely to result in an uptick in inflation in the coming months, weak domestic price pressure and the recent strengthening of sterling will keep the inflation rate trending towards the 2%y/y target. Assuming the Bank Rate follows the path of market yields, the inflation target will be reached a year earlier.
The central bank’s outlook for the labour market has also improved and the monetary policy committee now believe that there is a two in five chance that unemployment will reach 7% by the end of next year, and a three in five chance in 2015 (assuming the Bank Rate follows market rates). Considering the MPC have used the unemployment rate as a benchmark to re-evaluate monetary policy, there is a possibility that we could see a rate hike in late 2015. However, Governor Carney repeatedly highlighted the importance of reducing slack, claiming “A strong and sustained recovery is needed to put people back in work and use up the slack in the economy”. Therefore the MPC may hold back on raising interest rates until we witness such a “strong economy”. In addition, Carney outlined that a scenario where the Bank Rate was held constant “shows the potential advantages of keeping rates unchanged after hitting 7% unemployment”.
The main thing to remember is that despite the upward revision in growth projections, and confirmation that the recovery is strengthening, it doesn’t necessarily mean a rate hike is on its way. Although the unemployment rate is expected to reach the threshold earlier than predicted in the last inflation report, in Governor Carney’s words, “what really matters is what we will learn about the economy along the journey to that threshold”. We have seen how quickly the economic picture can change, and therefore it is important for focus to remain on what this picture is showing.
Sasha Nugent
Currency Analyst
