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Household saving in the UK is set to fall to its lowest level since at least the early 1960s, according to new Bank of England forecasts, boosting economic growth and taking some members of the Monetary Policy Committee closer to the limits of their tolerance for above target inflation. But, for now, the committee has voted unanimously to keep policy on hold.
The bank’s new forecast, published on Thursday, is for growth of 2 per cent this year, well above the 1.4 per cent forecast they made in November. Consumers are expected to save less to support higher spending than the bank had expected. Over the next few years, the additional government spending that was announced at the end of November, stronger growth in the US and the Euro area and a further easing of credit conditions are expected to provide a further boost.
The bank’s forecast now implies the economy will be 1.5 per cent smaller in three years’ time than they expected before the UK voted for Brexit in June. This is significantly smaller than 2.5 per cent reduction they projected in November.
Economic growth has been significantly stronger over the past six months than many forecasters, including the BoE, had expected. One of the main drivers of this has been robust consumer spending, supported by rapid growth in consumer credit, which governor Mark Carney has recently flagged as a potential concern for policymakers.
The bank’s new forecast suggests this trend is set to continue in 2017. Consumer spending will slow less quickly this year than the bank had predicted in November, despite rising inflation. This spending will be facilitated by households cutting their saving rate to the lowest level recorded since at least 1963, when comparable measures were first collected.
Growth is then expected to slow to 1.6 per cent in 2018 and 1.7 per cent in 2019, a little faster than predicted in November.
The bank’s forecast for inflation has remained largely unchanged. They continue to expect inflation to overshoot the 2 per cent target for a prolonged period, peaking at 2.8 per cent in the first half of 2018. Since November, sterling has appreciated, reducing upward pressure on inflation, since the bank’s last forecast. However, other factors – such as rising oil prices – have acted in the opposite direction.
Members of the policy-setting committee continue to face a trade-off between returning inflation to their 2 per cent target in a timely manner and providing support for jobs and economic activity. The committee reiterated their previous statements that there are “limits to the degree to which above-target inflation could be tolerated” but that monetary policy could next respond “in either direction”. However, the minutes recorded that, for some committee members, the latest revisions had moved them “a little closer to those limits”.
Despite the significant upgrade to growth, most of the committee members have remained sanguine about the expected rapid rise in inflation. Following an in-depth review of the UK’s labour market, the MPC members now judge there is greater scope for lower levels of unemployment without risking upward pressure on wages and prices.
In November, the bank forecast unemployment would rise from 4.8 per cent to 5.6 per cent by the start of 2019. They now expect unemployment to rise no higher than 5 per cent. Despite this, their forecast for wage growth over the next three years has fallen. This implies there will be 250,000 fewer people unemployed at the start of 2020 than they predicted in November.
The shift of opinion on the state of the labour market, which was flagged in a speech by MPC member Michael Saunders last month, helps explain why the committee members remain happy to tolerate a prolonged period of above-target inflation for now. However, the minutes of their meeting noted that “the more time passed without a noticeable reduction in economic growth, the more difficult it would become to tolerate the extent of inflation overshoot” suggested by their latest forecast.
The committee voted unanimously to leave policy unchanged on Thursday. The bank’s interest rate will remain at 0.25 per cent, total government bond holdings will be unchanged at £435bn and the bank will continue with its planned purchase of corporate bonds, which will rise to £10bn over the next year.