GB: BoE Inflation Report

Thu Feb 12 04:30:00 CST 2015

The BoE's new Quarterly Inflation Report (QIR) shows inflation falling to an average level of just above zero next quarter before, on current market interest rates, rising to 1.96 percent in two years' time and to 2.15 percent, and so above target, by early 2018.

However, while the new inflation forecasts hint that there may be some upside risks to interest rates further out, it is worth noting the generally dovish tone of BoE Governor Carney's letter to the Chancellor which explains why inflation is currently beneath its 1 percent lower target limit. In this the Governor somewhat surprisingly reneges on the Bank's previous assertion that official borrowing costs could not be cut any further for fear of damaging the workings of UK financial markets. Apparently, such risks are no longer viewed so significant and the letter points out that the Bank is prepared to cut Bank Rate (0.5 percent) and increase QE (Stg375 billion) should the threat of deflation become real.

That said, the BoE's new economic forecasts suggest that without the slide in oil prices, monetary policy might be tightened rather sooner than anticipated in the markets. Hence, expectations for real GDP growth have been revised up and spare capacity is now put at just 0.5 percent of total output, down 0.3 percentage points from the November QIR. Moreover, the ILO unemployment rate is seen falling to 5.5 percent in the third quarter and to 5.0 percent, the Bank's assumed long-term equilibrium level, by the end of the forecast period.

The bottom line is that the BoE does not want to be seen as hawkish at a time when inflation is well below target and almost certain to fall further near-term. As such, while the chances of a hike in Bank Rate this year probably remain less than 50 percent, the likelihood of a move in early 2016 has probably just got a little higher.

The Bank's quarterly Inflation Report was first published in 1993. The Report sets out the detailed economic analysis and inflation projections on which the Bank's Monetary Policy Committee bases its interest rate and other major policy decisions, and presents an assessment of the prospects for UK inflation.

For analysts who want to know the Monetary Policy Committee's latest thinking on the economy, the Inflation Report is must reading. The Report starts with an overview of economic developments; this is followed by five sections which include analysis of money and asset prices; analysis of demand; analysis of output and supply; analysis of costs and prices and assessment of the medium-term inflation prospects and risks. The Bank of England's governor holds a press conference to discuss the report.