This forecast, it said is based on the assumption that the: “Bank Rate rises gradually to 1.4% by 2018 Q2, in line with the path implied by market interest rates; and the stock of purchased assets remains at £375 billion.”
According to the Bank’s May Inflation report, the underlying causes of the current, below-target inflation rate of 0% are broadly similar to those outlined in February: significant price falls in food and fuel prices and (albeit to a lesser degree) below average growth in domestic unit wage costs.
The impact of the first set of factors is expected to drop out of the calculation toward the end of the year, which the Bank says, should result in a “notable” uptick in inflation toward the end of 2015.
The second part of the equation, wage growth, is, however, a tougher nut to crack.
The best collective view of the MPC is that the amount of slack in the economy has narrowed over the past six months to around 0.5% of GDP. But, it was quick to add, “there is considerable uncertainty around this estimate and a wide range of views across the Committee.”
According to the Bank, the path for inflation depends crucially on the outlook for domestic cost pressures.
If the labour market tightens further, and productivity increases, wage growth should be underpinned, but there remain a number of factors weighing on this outcome.
While the Bank expects pay growth to strengthen in the short term “driven by the narrowing in slack and a pickup in productivity growth, and as the temporary factors weighing on pay growth — such as compositional effects and subdued job turnover — diminish” it is uncertain about the persistence of these factors, which has led it to revise lower its expectations for growth in wages.
Speaking during the Q&A session following the release of report, Bank of England governor, Mark Carney said: “The uncertainty around the path for wages is considerable. Productivity growth is the key determinant, the timing and extend of any pick up in productivity growth remains our most difficult insight.”
Muddying the waters even further was the strength of the UK labour market as outlined in the latest figures from the Office for National Statistics. The number of people in employment grew by 202,000 in the first quarter of 2015, while the unemployment rate fell to 5.5% from 5.57% in the last quarter of 2014.
Guy Foster, Head of Research at Brewin Dolphin said: the market impact of the employment numbers was muted by the euphoria surrounding better French and Italian growth and the mixed tone of the report.
But, of the BoE’s comments, he added: “This appears to endorse the very dovish positioning already held by investors. Of course, what we know about central bank forecasting is that has been temperamental at best. Investors and businesses should expect further forecast changes in August’s report and, we suspect, a more hawkish tone.
