Presented as part of the central bank’s quarterly inflation report, Carney and his colleagues estimate that the UK economy will grow by 2 per cent this year, up from the previous estimate of 1.4 per cent.
He acknowledged that the previous forecasts were wrong, but said this was a consequence of better financing conditions for businesses and consumers, powering growth. Carney took the view that the improved conditions were the consequence of an interest rate cut.
Many market participants will find that a contentious view, the interest rate cut occurred in the days immediately after the EU Referendum result.
Julian Chillingworth, chief investment officer at Rathbone Unit Trust Management, has previously commented to What Investment that the upswing in business lending began to become apparent in the data last April, prior to the referendum result.
Guy Foster, head of research at Brewin Dolphin told What Investment that signs of stronger economic growth on a global scale have been apparent for quite some time, notably through the Purchasing Manager’s Index (PMI) data results from many developed markets.
PMI data is of particular value to economic forecasters because it is a measure of future intentions, rather than past actions.
A more positive PMI number indicates that participants intend to engage in extra economic activity in the months ahead, and that spurs growth.
Kathleen Brooks, research director at City Index, noted that sterling fell sharply in the wake of the Bank of England report.
That is because Carney and his colleagues did not revise upwards their forecasts for UK inflation. Brooks opined that the market had started to believe that very high inflation would force the central bank into pushing interest rates higher earlier than it presently intends.
Brooks commented that there may be a more long-lasting and profound reason for interest rate expectations to shift.
That was the Bank of England’s announcement that it was resetting the level of unemployment it considers ‘equilibrium’ to 4.75 per cent, instead of the previous number, 5 per cent.
This matters because the Bank of England would be less likely to put interest rates up (economic theory states that higher rates have a negative impact on employment levels) if the unemployment rates are higher than equilibrium. If the equilibrium rate is lowered, then the hurdles that the UK economy has to jump in order for the central bank to put rates up, grow.
The change in the equilibrium rate reflects the changing demographics of the UK economy, with proportionally more retired or semi-retired people of working age in the population that ever before.
That cohort of the population appear in the productivity statistics as a zero, in the wage statistics as a zero, and do not count as unemployed.
That is the reason the unemployment numbers were much lower than expected in the depths of the financial crisis, and why wages have not gone up despite the numbers in employment being high.
Brooks noted that the Trump administration in the US is urging the Federal Reserve, that country’s central bank, to adopt a similar policy.
Ben Brettell, senior economist at Hargreaves Lansdown commented that, ‘there has been plenty of positive data, with growth of 0.6 per cent in the final quarter. The PMI reading for the dominant services sector rose sharply in December, Q4 retail sales were 5.9 per cent higher than a year earlier, and unemployment remains at an 11-year low.’
He continued, ‘Inflation forecasts were little changed, with policymakers forecasting CPI inflation will peak at 2.8 per cent in the first half of next year, before gradually falling back towards its 2 per cent target. Unsurprisingly interest rates were left on hold, but the minutes noted that some MPC members were getting a little closer to the limits of their tolerance for higher inflation. This could mean we see the first interest rate rise in more than a decade at some point this year, particularly if wage growth turns out stronger than expected.’
The economist concluded his comments with the remark that, ‘However I still feel this is improbable. The most likely scenario is that higher inflation and weaker pay growth will squeeze household budgets, meaning consumer spending is likely to slow in real terms. The Bank is unlikely to take the risk of raising borrowing costs in this environment. If it does happen, I would expect rates to remain at their previous low of 0.5 per cent for some significant time afterwards.’
With around two-thirds of UK GDP coming from domestic consumption, the economy is particularly vulnerable to inflation reducing consumer spending power.
The Bank of England forecasts growth of 1.6 per cent in 2018 and 1.7 per cent in 2019.
Lucy O’Carroll, economist at Aberdeen Asset Management remarked that the big take out from today’s report was Mark Carney implying that the next move in UK interest rates will be upwards, which, she commented, ‘is quite a turnaround’ from the climate immediately after Brexit