The Bank of England revised up its growth forecast for 2021 on Thursday, but said that inflation would remain in check even as the recovery accelerated.
The central bank now expects the UK economy to grow 7.25 per cent this year, up from a previous forecast of 5 per cent made three months ago with households much more willing to spend accumulated savings built up during the pandemic.
The higher growth estimate all but eliminates the likelihood that the BoE will set a negative interest rate this year and suggests instead that rates will begin to rise in 2022.
After its May meeting, the bank’s Monetary Policy Committee voted unanimously to hold interest rates at the historic low of 0.1 per cent.
However, there was a surprise dissent from chief economist Andy Haldane on the total amount of quantitative easing. While eight of the nine committee members voted to maintain the stock of money to be created in order to buy assets at £895bn by the end of this year, he preferred to limit the size to £845bn.
Some of this more rapid recovery was likely to lead to a slower expansion in 2022, the MPC said, revising down its expectation of growth next year to 5.75 per cent from 7.25 per cent in the February forecasts, although the forecast was stronger across the whole three-year period.
With the positive news and the extension of government support for jobs, the BoE now thinks unemployment will peak at only 5.5 per cent compared with a peak of 7.75 per cent it had previously pencilled in. In the longer term, the BoE now thinks there will also be less deep scars from Covid-19, revising down the longer-term hit from 1.75 per cent to 1.25 per cent.
Inflation would stay under control even with the better outlook, the bank said, partly because it based its new forecasts on market expectations that it would raise interest rates earlier, damping the bounce back in economic activity.
It did say that inflation towards the end of this year would rise to 2.5 per cent, but would then fall back to the BoE’s 2 per cent target by the end of 2022.
In February, the forecasts were based on an assumption that interest rates would need to be set at negative rates for the first time this year and would still be zero per cent after three years to stop inflation falling persistently below the BoE’s 2 per cent target.
Since then, financial markets have bet on much tighter monetary policy being needed for stable inflation. The latest forecasts are based on an assumption that interest rates will begin to rise in 2022 and increase to 0.65 per cent in three years’ time.
The improvement in the growth forecasts with stable inflation validated the hawkish change in view from financial markets.
The MPC, however, reiterated that it intended to wait until it was certain that inflationary pressures were real and the 2 per cent target would be met “sustainably” before it began to tighten policy.
The BoE considers the pace at which it operates the quantitative easing process of creating £895bn to purchase mostly government bonds as an operational matter.
It had planned to purchase £150bn of assets in 2021 and by the end of April had bought £67bn. The bank said that, while it was ahead of target for the year, “the pace of these continuing purchases could now be slowed somewhat”.
“This operational decision should not be interpreted as a change in the stance of monetary policy,” it added, although markets are likely to interpret the move as hawkish.
Gilt yields edged up slightly following the confirmation that the BoE plans to slow the pace of bond purchases — as it had signalled previously and most investors expected. The 10-year yield rose 0.02 percentage points to 0.82 per cent.