The Monetary Policy Committee (MPC) of the Bank of England sets monetary policy to achieve the 2% inflation objective and in a way that supports growth and employment. At its meeting that ended on November 2, 2022, the BOE decided to raise the bank rate by 0.75 percentage points, to 3%, by a vote of 7-2. Both members preferred raising the bank rate by 0.25 percentage points to 2.5% and by 0.5 percentage points to 2.75%, respectively.
The MPC's updated activity and inflation predictions, which are detailed in the accompanying November Monetary Policy Report, provide a rather bleak picture of the UK economy's future.
There have been considerable changes in fiscal policy conditions since the MPC's prior prediction. Following additional government measures, uncertainty on the forecast for UK retail energy prices has decreased to some extent.
The MPC's working assumption for the current November forecast, in line with the Government's announcements on October 17, is that some fiscal support will continue after the current Energy Price Guarantee (EPG) period of six months, resulting in a stylized path for residential energy prices over the following two years.
With such assistance, the energy portion of the CPI inflation would be mechanically restrained from rising further and its volatility would be decreased. However, the support could increase inflationary pressures in non-energy goods and services by increasing aggregate private demand in comparison to the August predictions.
In relation to the August prediction, additional fiscal measures revealed up to and including October 17 also enhance demand. Any additional measures that might be disclosed in the Autumn Statement, which is due for November 17, are not included in the MPC's forecast.
Since the August Report, there have been significant changes in UK asset prices. Although UK-specific causes have had a very significant impact over this time, these partially reflect worldwide developments. The Bank Rate's implied trajectory in the seven business days before to October 25 is what the MPC's estimates are dependent on. In the third quarter of 2023, that trend peaked at about 51% before declining. Over the next three years, the path is generally about 214 percentage points higher than in the August forecast. The steep increase in new mortgage rates is a result of the stronger market yield curve. The tightening of financial conditions has significantly reduced activity over the anticipated period.
During 2022 H2, the GDP is predicted to contract by about 34%, in part due to the compression on real earnings brought on by rising global energy and tradeable goods costs. However, due to support from the EPG, the decline in activity around the conclusion of the current year is anticipated to be less pronounced than it was in August. Although there are indications that labor demand is starting to lessen, the labor market is still tight.
Inflation measured by the CPI was 10.1% in September and is anticipated to increase to roughly 11% in 2022 Q4, which is lower than anticipated in August due to the effects of the EPG. The CPI for services is now rising. In the three months leading up to August, nominal annual regular pay growth in the private sector increased to 6.2%, which is 0.6 percentage points more than forecast in the August Report.
GDP is predicted to continue to decline during 2023 and 2024 H1 in the MPC's November central estimate, which is dependent on the higher trajectory of market interest rates, as high energy prices and considerably tighter financial conditions restrain spending. By the conclusion of the projection, the four-quarter GDP growth accelerates to almost 34%. Despite the fact that there is now believed to be a sizable margin of excess demand, prolonged weakness in expenditure is likely to cause an increase in economic slack to emerge from the first 50 percent of next year, including an increase in the unemployment rate. By the conclusion of the forecast period, it is anticipated that the LFS rate of unemployment would grow to just under 612% and that aggregate slack will rise to 3% of potential GDP.
As energy price rises are removed from the annual comparison, the MPC's key prediction for CPI inflation shows a decline beginning in the first quarter of the following year. In the ensuing quarters, domestic inflationary pressures will be persistent before easing. In two years, it is anticipated that CPI inflation will drop significantly to some extent below the 2% target.
Although GDP is still anticipated to be declining by the end of 2023, predictions based on the alternate assumption of stable interest rates at 3% show activity to be better than in the MPC's projection conditioned on market rates. At the end of the second year, CPI inflation is anticipated to be a bit higher than the target. At the end of the third year, it, nevertheless, is more than one percentage point behind the aim.
However, the risks surrounding both sets of inflation estimates are deemed to be upside-skewed in the longer run, partially due to the potential for more tenacity in price and wage setting.
It is quite obvious from the MPC's mandate that the inflation target is always in effect, highlighting the importance of stable prices in the UK's monetary policy framework. The framework admits that there will be instances in which shocks and disturbances will cause inflation to deviate from the target. There have been several very significant shocks to the economy. As these shocks are continued to be adjusted for, monetary policy will make sure that the medium-term CPI inflation rate returns stably to the 2% objective. Additionally, monetary policy works to maintain longer-term inflation expectations at the 2% objective.
The labor market is still tight, while there have been persistent indications of sharper domestic price and wage inflation, which could point to greater persistence. Relative to the Committee's August predictions, the recently announced fiscal policies, particularly the MPC's working assumption concerning continuing financial assistance for household energy costs, will also strengthen demand. At its meeting in December and in its next projection for February, the Committee will take into account any further information in the Government's Autumn Statement.
The Committee has decided to raise the Bank Rate by 0.75 percent, to 3%, at this meeting in light of these factors.
The large percentage of the Committee believes that additional increases in the Bank Rate may be necessary to sustainably bring inflation back to target, albeit at a peak that is lower than what financial markets have priced in, should the economy develop largely in line with the projections in the most recent Monetary Policy Report.
The prognosis is, however, surrounded by a lot of uncertainty. The Committee maintains its assessment that it will act aggressively as necessary if the outlook points to more persistent inflationary pressures.
In accordance with its mandate, the MPC will take the steps required to bring inflation back to the 2% objective in the medium run. At each meeting, the Committee will, like always, discuss and decide on the best level of the bank rate.
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