What to expect from tomorrow's Bank of England Inflation Report

Tomorrow sees Mark Carney's first Inflation Report as governor of the Bank of England, which should come with an additional statement on the central bank's plans for forward guidance.

Berenberg chief economist Rob Wood gives his assessment of what we might expect:

Here comes guidance

The BoE will make an announcement on guidance alongside the Inflation Report tomorrow. We do not expect the BoE to give a dovish surprise, but rather see it confirming market expectations that the first rate rise will not come until early 2016.

The stimulus is working

The UK is seeing a consumer-led recoveryas tumbling mortgage rates and improved confidence start people out spending. The composite PMI surged to a record high in July.

Growth up, inflation down

The BoE will probably raise its growth forecasts for 2013 and 2014, reflecting the recent stronger momentum. That will lead to modestly higher inflation at the two-year point. The BoE is still an inflation-targeter, so inflation is still likely to return to target by the end of the BoE’s three-year forecast.

Growth depends on continued rock-bottom interest rates

The recovery could quickly lose steam if mortgage rates rise, so the BoE’s job now is to use guidance to ensure that the stimulus is not withdrawn prematurely. Now is the time that guidance is important, as it can dampen any expectations of rate rises.

“Cautious” guidance

The BoE is unlikely to want to do more than confirm current market expectations. A majority of policy-makers said in their July meeting that they did not want further stimulus and the PMIs now point to much stronger growth than their last forecast. So it is unlikely that they would now sign up to super-dovish policy.

Economic threshold most likely option

Our note, What if Britain introduces guidance?, dated 23 July, goes through the options. The frontrunner in our view is that the BoE ties interest rates to an unemployment threshold. If the BoE does this, then it would probably say rates will stay low until unemployment falls to 7% as long as inflation is expected to be close to target in three years’ time.

Possibility of watered-down guidance

We continue to see a onethird chance that getting the hawks on-side means the BoE goes for a face-saving alternative, whereby it publishes an interest-rate forecast rather than adopting a formal threshold.

Is growth cyclical or structural?

The key question, as ever, is whether the recovery is cyclical or structural. If the recovery is cyclical, it will cause higher inflation. If it is structural then the UK can have jam today and tomorrow: stronger growth today and in the future without higher inflation.

It is partly structural

We expect the BoE to conclude that better expected growth over the next year or two is partly structural. In other words, rates can stay low because the recovery is not inflationary.

We raise our forecasts

The strong rises in the PMIs this month have prompted us to raise our GDP growth forecasts to 1.4% for 2013 and 2.3% for 2014, up from 1.0% and 1.8% respectively.

Balanced risks

We see the risks to our forecast as balanced, and expect the BoE to reduce the downside risks to its forecast tomorrow. On the one hand, real wages are still falling so consumption growth could sag later this year. On the other hand, the US and Eurozone are looking stronger, and investment could improve as confidence rises.