Bank of England sees higher inflation but cuts GDP and wage forecasts

The UK economy will grow slower in 2017 than the Bank of England predicted only three months ago, monetary policymakers revealed on Thursday, as inflation is seen hitting a higher peak this year.

The Bank's Monetary Policy Committee, alongside a decision to stand pat on interest rates for another month, cut its 2017 forecast for gross domestic product to 1.7% from the 1.9% prediction made in May, with the forecast for 2018 trimmed to 1.6% from 1.7%.

With consumer price inflation rising to 2.6% in June from 2.3% in March, as the MPC had anticipated, the committee expects inflation to peak around 3% in October rather than 2.8% as previously thought, as the weakness of the pound since the Brexit vote continues to pass through.

The BoE's long-term target is to keep the annual inflation rate at around 2%, it is still seen remaining above that level for at least two more years, with the Inflation Report nudging up its 2018 forecast to 2.5% from 2.4%, and keeping the 2019 prediction at 2.2%

Although recent data points to sluggish economic activity, the MPC said that while it projects growth to slow further in the near term, this does not alter its view medium-term view that the output gap will close towards the end of its forecast period.

The MPC thinks growth will pick up over 2018, with consumption growth remaining subdued as households continue to adjust to a period of weak real income growth but strong global growth supporting net trade and business investment.

"That outlook is consistent with expectations, on the part of households and businesses, of a smooth transition to post-Brexit trading arrangements."

The impact of sterling’s renewed depreciation on inflation was largely offset by the MPC’s decision to revise down its forecast for wage growth next year to 3% from 3.5% and for 2019 to 3.25% from 3.75%.

There are several possible reasons for wages to remain depressed in spite of the low levels of unemployment and rising inflation, the committee suggested.

Uncertainty around the economic outlook, was one such factor, with households’ concerns about the coming months leaving them "reluctant to push for faster pay growth".

"Uncertainty about the economic outlook may also affect companies’ willingness to raise pay at a faster pace until they have more clarity about future demand," the Inflation Report said, noting that its recent agents report showed evidence of this.

The MPC's projections assumed two rate hikes over the next three years, with the first hike not until the third quarter of 2018, though the committee said “monetary policy could need to be tightened by a somewhat greater extent over the forecast period than the path implied by the yield curve underlying the August projections”.

Given than the committee nudged down its forecasts, the MPC looks in no rush to raise interest rates, said Paul Hollingsworth at Capital Economics.

Sam Tombs at Pantheon Macroeconomics said the committee's statement "falls a long way short of giving markets a strong steer" and said the decision to end the term-funding scheme as planned in February 2018 will raise the marginal cost of new lending for banks by forcing them to seek long-term funding from wholesale markets or depositors.

"This move swiftly follows the FPC’s decision in June to raise the counter-cyclical capital buffer and signals that the Bank is willing to deploy its macroprudential tools to cool lending growth and thereby delay the first rate hike."

While some will quite fairly point to the forecast downgrade as evidence that Brexit is taking its toll on the UK economy, Laith Khalaf at Hargreaves Lansdown said the overall economic performance has been better than expected since the EU referendum, particularly in light of some of the dire forecasts that preceded the vote.

"The Brexit process is really only just beginning, and it will have many long-lasting implications," he opined. "Consequently the task of determining just what effect Brexit had on the UK economy will mostly fall on the shoulders of tomorrow’s historians, rather than today’s economists."