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Inflation expected to peak at 2.8% in the first half of 2018

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Written by: Paloma Kubiak
02/02/2017
The Bank of England has edged upwards its inflation expectations amid the weakness of sterling but UK growth forecasts are also on the rise.

The Bank of England’s Inflation Report published today includes forecasts on CPI rates, as well as the UK’s predicted growth. The Monetary Policy Committee (MPC) also took a decision on the Bank Base Rate.

Below is a summary of the forecasts and decisions made:

Bank rate and bond purchases

The MPC voted unanimously to maintain the Bank of England Base Rate at the unprecedented low of 0.25%, after cutting the rate from 0.5% in August.

However, based on predictions of slower growth in 2017, as well as sterling weakness, the markets assume that the Bank Rate is on the path to rise to “just under 0.75% by early 2020”.

The MPC also confirmed it will continue with the programme to purchase corporate bonds totalling £10bn and extending its asset purchases to £435bn.

Inflation

With the value of sterling remaining 18% below its peak of November 2015 and as this downward trajectory expected to continue, the MPC said this will lead to higher import costs, in turn resulting in a boost to consumer prices which will cause inflation to overshoot the 2% target.

“This effect is already becoming evident in the data. CPI inflation rose to 1.6% in December and further substantial increases are very likely over the coming months. In the central projection, conditioned on market yields that are somewhat higher than in November, inflation is expected to increase to 2.8% in the first half of 2018, before falling back gradually to 2.4% in three years’ time.  Inflation is judged likely to return to close to the target over the subsequent year,” the committee noted.

In December 2016, the MPC expected inflation to reach its 2% target “within six months” with a rise to 2.75% in 2018 before falling in 2019 to about 2.5% in three years’ time.

Growth

The MPC has increased its expectation for growth in 2017 to 2.0% and it expects growth of 1.6% in 2018 and 1.7% in 2019.

The report stated the upgraded outlook over the forecast period reflected the fiscal stimulus announced in the Chancellor’s Autumn Statement, as well as “firmer momentum in global activity, higher global equity prices and more supportive credit conditions, particularly for households”.

It noted that domestic demand has been stronger than expected over the past few months, and there have been relatively few signs of the slowdown in consumer spending that it had anticipated following the referendum.

“Nevertheless, continued moderation in pay growth and higher import prices following sterling’s depreciation are likely to mean materially weaker household real income growth over the coming few years.  As a consequence, real consumer spending is likely to slow,” the committee cautioned.

‘Outlook for economy remains strong but risks on the horizon’

Adrian Lowcock, investment director at Architas, said the Bank of England’s growth forecast for the UK has risen considerably, driven by a combination of a loosening of fiscal policy and an improved global economic outlook.

“The cut in interest rates and reintroduction of quantitative easing in August last year helped support household incomes and contributed, in part, to the consumer remaining more confident than expected following the Brexit vote. The Bank of England so far look’s comfortable to let inflation run above the 2% target, peaking at 2.8% in 2018, as it is largely driven by the weaker pound.”

“Whilst the outlook for the UK economy remains strong there are still significant risks on the horizon. The full impact of Brexit is yet to be felt and the stronger consumer confidence which has supported the stronger economy has been driven by cheaper borrowing costs and from households dipping into their savings. The UK now has the lowest savings rate on record. Any rise in inflation and interest rates could have a significant impact on consumer spending.”

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