The Bank of England forecast a much stronger economic recovery from the pandemic this year built on the back of higher consumer spending, but said that inflation would remain under control even if it overshot the target briefly in late 2021.
The central bank now expects the UK economy to grow 7.25 per cent this year, the highest rate in more than 70 years and up from a previous forecast of 5 per cent made three months ago.
The higher growth estimate all but eliminates the possibility that the BoE will set a negative interest rate this year and suggests instead that rates will begin to rise in 2022.
Instead, Andrew Bailey, BoE governor, said that although he expected inflation to ebb after a rapid increase above the bank’s 2 per cent target this year, the Monetary Policy Committee would need to keep alert that a temporary overshoot does not become persistent. “We will watch this extremely carefully,” he said.
At its May meeting, the bank’s MPC voted unanimously to hold interest rates at the historic low of 0.1 per cent.
However, there was a surprise dissent from outgoing chief economist Andy Haldane on the volume of quantitative easing. While eight of the nine committee members voted to maintain the stock of money to be created in order to buy assets at £895bn by the end of 2021, he preferred to limit the size to £845bn.
The MPC’s minutes showed Haldane thought there were good reasons to worry that inflation could rise too far and stay too high, but the majority on the committee thought tax increases and lower public spending would bring the growth rate down in 2022.
With the positive news and the extension of government support for jobs, the BoE now thinks unemployment will peak at 5.5 per cent, compared with its previous estimate of 7.75 per cent. In the longer term, the BoE now thinks there will also be less deep pandemic scars, revising down the longer-term hit from 1.75 per cent to 1.25 per cent.
But Bailey noted that the fast growth forecast this year would be achieved only because the economy had sunk so far last year. “Let’s not get carried away,” he said. “[The strong recovery] takes us back by the end of this year to the level of output we had at the end of 2019 . . . two years of output growth have been lost.”
The latest BoE forecasts were based on prevailing market interest rates, which suggested the central bank would start raising interest rates next year, reaching 0.6 per cent in three years’ time, to keep inflation close to the 2 per cent target.
February’s forecasts were based on an assumption that interest rates would need to be set at negative rates for the first time this year and would still be zero per cent after three years to stop inflation falling persistently below the BoE’s target.
The new forecasts therefore validated the more hawkish views of the markets reflecting the improvement in the economic and coronavirus outlooks over the past quarter.
The MPC, however, reiterated that it intended to wait until it was certain that inflationary pressures were real and the 2 per cent target would be met “sustainably” before it began to tighten policy.
The BoE considers the pace at which it operates the quantitative easing process as an operational matter.
It had planned to purchase £150bn of assets in 2021 and by the end of April had bought £67bn. The bank said that, while it was ahead of target for the year, “the pace of these continuing purchases could now be slowed somewhat”.
“This operational decision should not be interpreted as a change in the stance of monetary policy,” it added, although markets are likely to interpret the move as hawkish.
Gilt yields edged up slightly following the confirmation that the BoE plans to slow the pace of bond purchases — as it had signalled previously and most investors expected. The 10-year yield rose 0.02 percentage points to 0.82 per cent.