Bank of England warns of ‘moderate’ growth as Brexit-fuelled inflation bites

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The Bank of England expects the economy to do slightly worse this year than it forecast, but predicts it will improve next year and in 2019.

They also made no change to interest rates.

There are three important points to note following Wednesday’s announcement:
Compared to the pre-crisis era, the economy on many counts still looks considerably worse.
The Bank’s forecasts’ assumptions about the Brexit effect on the economy – which are based on an average of potential post-Brexit trade scenarios – may of course be very far from what the ultimate Brexit deal looks like. Whilst its assumption that the adjustment to the UK’s new relationship with the EU is “smooth” may of course not be borne out.
One of the Bank’s key judgements is that net trade contributes positively to growth for much of the forecast period. This may or may not be borne out depending on the ultimate Brexit deal.

GDP forecasts are pretty much the same as those made in February. With the economy expected to grow at 1.9% this year, 1.7% next and 1.8% the year after.

Forecasts for this year have been slightly revised downwards. Whilst for next year and the year after they have been slightly revised upwards.

The downward revision for this year is basically because of the squeeze on household incomes which is now being felt given rising inflation/slowing wage growth.
Other indicators such as recent retail data supports that.

Why things look slightly better in the future is largely to do with the Bank’s belief that the global economy will now do slightly better than expected, business investment looks better than expected and that sterling has proved stronger than expected in recent months.

Sterling went up quite a lot between Feb and May – 2.5%.

Inflation is expected to be slightly higher than expected this year. But better than expected back in 2018 and 2019.

This is largely due to the expectation that sterling will remain stronger than expected.

Real income growth is expected to be particularly weak this year – and real wages to fall – as companies hold back from raising wages given Brexit uncertainty.

But is then expected to recover somewhat next year and the year after.

Even so, the bank does stress that real income growth “remains well below past average rates.”

Before the financial crisis it averaged 3% a year, this year it will be only 0.25%.

Compared to the pre-Financial Crisis era (1998-2007), it is clear the economy on several measures is still doing much worse.

Household consumption will grow at less than half the rate of that period (although debt played a significant role in this so wasn’t necessarily a good thing), the rate of growth of both imports and exports is dramatically less, and the growth in real post-tax household income remains significantly lower than its average back then – 0.25% this year as compared to an average of 3% back then.

Interest rates will remain the same – 0.25%.

The markets had expected more dissent amongst MPC members but again only Kristin Forbes voted to raise them.

Expectations are that they continue to remain low, although a potential rate hike to 0.5% by 2020 was flagged, but the bank made clear that were their forecasts not to play out as expected, this may of course change.

Although there has been a slight fall in the savings rate the Bank cautions not to over interpret this given that the ONS has said it is going to revise savings rate data up significantly.
Last updated Thu 11 May 2017