BoE eyes '˜moderate' growth as rates left on hold

The Bank of England has warned the squeeze from Brexit-fuelled inflation on household income has begun and said growth would remain 'moderate' after faltering at the start of the year.

The Bank of England lowered its growth forecast for 2017 to 1.9%. Picture: Peter Macdiarmid/Getty Images
The Bank of England lowered its growth forecast for 2017 to 1.9%. Picture: Peter Macdiarmid/Getty Images

Policymakers on the monetary policy committee (MPC) kept interest rates on hold at 0.25 per cent as they nudged down the Bank’s growth forecast for 2017 to 1.9 per cent, down from 2 per cent in February, after a sharp slowdown in the first three months of the year.

The Bank said consumers were beginning to feel the pinch from surging inflation as the pound’s plunge since the Brexit vote has pushed up prices.

It said inflation would hit just under 3 per cent in the fourth quarter, far outstripping wage rises, which will see households rein in spending.

Economic growth pulled back sharply to 0.3 per cent in the first three months of the year, from 0.7 per cent in the previous three months after a sharper-than-expected fall in consumer spending.

The Bank said, while it expects first quarter expansion to be revised higher to 0.4 per cent, the economy would likely continue at a “similarly moderate pace of growth in the second quarter and beyond”.

Governor Mark Carney said the forecasts were based in part on “the adjustment to the UK’s relationship with the EU being smooth”, with expectations that the government will introduce a transition period to avoid a cliff-edge departure from the single market.

He said a whole different forecast would have to be produced to estimate the impact of a rocky or disorderly Brexit.

“We have not done that, what I can say is that, as has been the case since our August forecast, we have assumed that the process of leaving the European Union would be a smooth one,” Carney said.

“What does that mean? It means there will be an agreement as to future trading arrangements and there will be a transition or an implementation period to that new agreement.”

Carney said the MPC also issued its forecast assuming a “significant pick-up in wage growth”, due in part to business concerns over the Brexit process starting to ease.

“There is some evidence that businesses are hesitating to bring in higher wage costs at a time of some uncertainty about market access and other costs that could be associated with the Brexit process, resulting in more modest wage settlements.”

But if wage growth fails to rise, “there will be consequences”, the governor warned.

CBI chief economist Rain Newton-Smith said: “The MPC remained in wait-and-see mode this month, following slower growth in the first quarter, tepid wage growth and signs that household spending is coming under pressure.

“The next government must truly get behind a new industrial strategy to drive growth and job creation across the UK and also deliver a new migration system that ensures firms have access to the skills and labour they need post-Brexit.”

Minutes of the rates meeting showed seven MPC members voted to keep rates unchanged, while outgoing policymaker Kristin Forbes remained the sole dissenter, repeating her call for a rise to 0.5 per cent.

Calum Bennie of Scottish Friendly said: “It’s positive news for homeowners but cash savers must feel there’s no end in sight for the dire returns they’re getting. An interest rate rise may be on the horizon in the second half of 2017 and homeowners should be on the alert for the higher mortgage payments this would mean.”

In today’s report, the Bank cautioned that the expected slowdown in consumer spending “may have started”, adding that growth had fallen “markedly” in the first quarter and a “slowdown appeared to be in train”.

This was “concentrated in consumer-facing sectors, consistent with the impact of the fall in the exchange rate feeding through to household income and spending,” the Bank added.

But its quarterly inflation report signalled that this year would be the worst for the income squeeze, predicting that real wages would begin to pick up over the next three years, while the pound’s recent rebound would limit the surge in inflation.

The report, released alongside the rates decision, also offered some cheer for the growth outlook as forecasts were raised to 1.7 per cent for 2018 and 1.8 per cent in 2019, up from February’s predictions of 1.6 per cent and 1.7 per cent respectively.

The Bank said growth would be supported by a recent recovery in business investment and higher exports amid a bounce-back in the global economy.

While inflation, currently at 2.3 per cent, would likely remain above the 2 per cent target “throughout the next three years”, the Bank said the pound’s gain after the general election would help inflation ease back in 2018 and 2019.

Minutes of the rates meeting suggested the next move in rates would still be a rise, with other MPC members repeating it would take “little further upside news” to consider joining Forbes in voting for a hike.

The Bank added that financial market assumptions for just one rate rise to 0.5 per cent in 2020 would not be enough to rein in inflation. But many economists do not expect rates to rise until 2019 at the earliest.

Reaction from Royal Bank of Scotland

Inflation higher, wages lower, growth weaker. The main changes in the Bank of England’s forecasts don’t make for pleasant reading. But underneath the surface there are reasons for optimism, writes Sebastian Burnside, senior economist at RBS.

Growth is expected to be slower than it was back in February, but only just. Most of that slowdown reflects the dose of reality that arrived in Q1 this year as consumers put an end to their astonishing retail sales run. A more realistic pace of spending should mean a more solid financial footing. No bad thing, given households spent £6bn more than they earned in Q4 last year.

The picture got brighter for businesses as well. The Bank of England reckons that firms are planning to invest more than it previously assumed. It’s now forecasting growth of 1.75 per cent this year, compared to an outright contraction in the wake of the Brexit vote.

These forecasts highlight the challenges ahead for Scotland’s growth prospects. The squeeze on households’ real incomes will be the biggest pressure point this year. Services output was flat in Q4, so any further pull back in consumer spending will make growth even harder to find. Stronger business investment would provide some much needed balance.