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The key event for the UK market last week was the latest release of the Bank of England’s Quarterly Inflation Report combined with the press conference following the MPC meeting.
While the MPC was never expected to make any changes to its current monetary stance, the market had assumed that, having managed to completely misjudge the economic impact of the Brexit vote, it might also start to look at the actions it took based on its very pessimistic view of the economy following the referendum result, and now start to reverse them. This was expected particularly given the additional push towards above-target inflation by the depreciation in the currency.
If one had been expecting any signs of embarrassment over its previous forecasts and resultant monetary stance, one would have been quickly disabused. Indeed the Bank has gone from one extreme to the other, raising its forecast for GDP growth in the current year to 2% (having increased it to 1.4% only three months ago). This is considerably higher than almost any independent forecaster is predicting, although most are busy revising their own growth forecasts higher. The Bank’s rationale for its increase is largely driven by the better-than-expected outcome for the final quarter of last year, and they are now coming round to the belief that Brexit will not bring about a notable reduction in consumer spending just yet. Furthermore, the Bank expects the global economy to provide greater support, with the prospect of tax cuts and infrastructure spending to be announced by the new Trump presidency being noted. The fear of China going in the opposite direction seems to have now completely dissipated despite them providing a quick reminder in the form of a rate hike last week.
The inflation forecasts, in contrast, were little changed from those in November’s report and continued to show the CPI measure moving up to just short of 3% during this and next year. The MPC has made it clear that as long as it regards the above-target rate of inflation to be exchange rate-supported, therefore temporary, it will ‘look through’ the fact that it is anticipating an above-target rate for its full forecasting period. Given that this goes out for a two-year period, it would be interesting to know how the Bank might define ‘temporary’. It would appear that the Bank is more concerned about other inflationary forces such as the continuing fall in unemployment. However, that is an easy one to deal with when you decide to reduce your estimate of the equilibrium rate of unemployment from 5% to 4.50%. How this adjustment was justified did not seem to require any explanation – but it is a long way from the 7% that Mark Carney defined when he first arrived. The other employment-linked indicator is that growth in average earnings remains at modest levels.
Another of the key points for the MPC is the level of household borrowing, which continues to rise at a rate which the Bank of England finds increasingly alarming, particularly considering the squeeze that higher inflation is starting to have on average take-home pay. Last week it was out warning that it might take action by restricting the banks from continuing to lend to consumers at current levels. The more normal way to put people off borrowing would be to increase interest rates. However, when this very logical solution was proposed to the Governor at the press conference, it appeared that any problems that consumer spending might be posing had suddenly dissipated.
While the Inflation Report made it clear that some committee members were not as relaxed as the Governor about pursuing a monetary policy that almost completely ignored the threat that inflation might represent in the relatively near future, the overriding impression from the last week is that it would take a major crisis to persuade Mark Carney that a rate hike was justified prior to his retirement.
Little economic news of note to be announced this week, with just the latest industrial production and trade figures to emerge on Friday. Back to Brexit…
All views expressed here are the Author’s own and are based on information available at the time of writing.
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