Bank of England keeps interest rates flat - but says there are limits to how much above-target inflation can be tolerated

William Turvill
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Governor Mark Carney Presents Bank of England's Financial Stability Report
Mark Carney is governor of the Bank of England (Source: Getty)

The Bank of England kept interest rates flat as it revealed ramped-up forecasts on inflation and growth today.

But the the Monetary Policy Committee (MPC), which met yesterday and voted unanimously to keep rates at 0.25 per cent, has indicated “there are limits to the extent to which above-target inflation can be tolerated”.

The increased inflation forecasts were linked to the fall in value of sterling, which has been linked to the government’s so-called “hard Brexit” target.

Read more: Politicians react to Carney's 2019 decision

The MPC said: “Market intelligence attributes these latter movements to perceptions that the United Kingdom’s future trading arrangements with the EU might be less open than previously anticipated, requiring a lower real exchange rate to improve competitiveness and support activity.”

In August, governor Mark Carney - who this week decided to stay on in his position until 2019 - unveiled a massive stimulus package, which included slashing rates to 0.25 per cent, their lowest-ever level in the Bank’s 322-year history.

Sterling fall ramps up inflation forecasts

The Bank’s inflation forecasts have been increased “largely as a result of the depreciation of sterling”.

Inflation is expected to hit 1.3 per cent this year - up from August’s forecast of 0.8 per cent - and 2.8 per cent in 2017, up from the 1.9 per cent previously anticipated.

The figure is expected to drop to 2.7 per cent in 2018 (previous forecast 2.4 per cent) and 2.5 per cent in 2019. The Bank said it expects inflation to fall close its its two per cent target in 2020.

On the possibility of further action to address above-target inflation, the committee said:

The MPC’s remit requires that monetary policy should balance the speed with which inflation is returned to the target with the support for real activity. Developments since August, in particular the direct impact of the further depreciation of sterling on CPI inflation, have adversely affected that trade-off. This impact will ultimately prove temporary, and attempting to offset it fully with tighter monetary policy would be excessively costly in terms of foregone output and employment growth. However, there are limits to the extent to which above-target inflation can be tolerated.

Read more: Mark Carney to step down as governor of the Bank of England in 2019

GDP growth forecasts improve in short-term

Boosted by household spending and the housing market, the UK economy is expected to grow 2.2 per cent this year - up from the Bank’s previous estimate of two per cent - and then 1.4 per cent in 2017, up from 0.8 per cent.

The Bank said GDP growth in the third quarter - 0.5 per cent - was above expectations, saying: “These data suggest that the near-term outlook for activity is stronger than expected three months ago.”

While investment intentions have “continued to soften and the commercial property market has been subdued”, household spending has grown faster than expected and the housing market has proved “more resilient” than anticipated.

GDP growth is expected to dip to 1.5 per cent in 2018 and then edge up to 1.6 per cent in 2019.

The MPC attributed the longer-term drop to “the impact of lower real income growth on household spending”.

The committee said: “It also reflects uncertainty over future trading arrangements, and the risk that UK-based firms’ access to EU markets could be materially reduced, which could restrain business activity and supply growth over a protracted period.”

Unemployment forecasts are largely unchanged from August’s projections, rising from 4.9 per cent this year to 5.6 per cent in 2018 and 2019.

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