The BOE’s latest quarterly inflation report turned out to be more dovish than expected. Although policymakers raised the GDP growth forecast to +3.5% from +3.0% previously, they were concerned about the “heightened uncertainty” of slack in economy. The central bank also warned of weakness of pay growth and noted that rate hike would be “gradual and limited”, a comment that sent no further indication of the BOE’s tightening schedule. On global economic outlook, BOE Governor Mark Carney indicated that “geopolitical risks have intensified, and structural adjustment continues in the euro area, where growth is expected to be modest”. Meanwhile, “financial conditions are likely to tighten as the global recovery progresses”.
Domestically, the BOE raised its 2014 growth forecast to +3.5% from +3.4%. It also expected inflation to be around +1.8% in 2 years’ time. Despite these, the central bank noted that the economic expansion “faces some challenges” as “sustained expansion here at home will ultimately require growth in productivity and real incomes, both of which have disappointed”. The central bank also lowered its forecast for wage growth from 2.5% to 1.25% for this year, before acceleration in 2015. As stated in the minutes, “in light of the heightened uncertainty about the current degree of slack, the Committee noted the importance of monitoring the expected path of costs, particularly wages”. A highlight from the report is that the BOE has attached great importance to wage growth in “assessing inflationary pressures”. Given the improvement in the job market in recent months, the BOE forecast that the unemployment rate would drop to 5.4% in 2 years’ time, lower than the 5.9% projected in May.
Talking about the slack, the central bank reduced its estimate from a range of between 1% and 1.5% to just 1%. The central bank indicated that it preferred slack to be largely used up before tightening begins. As the central bank noted higher uncertainty about slack, it signals that there was a wide range of views regarding how much slack has left and when the rate hike should begin.
The BOE forecast the first rate hike to take place in 1Q15 and the policy rate would reach 2% by 4Q16. According to Carney, “the path of Bank Rate implied by market yields, and on which this forecast is conditioned, rises by only 15 bps per quarter and reaches only 2.25% by the end of the forecast period… Those rate expectations stem from the persistence of the headwinds facing the economy”. Again, the BOE reiterated that the progress of rate hike would be gradual and slow and the path of tightening would be data-driven.