Threadneedle Street said the collapse in GDP growth in the first quarter of 2018 was “likely to have been overstated” thanks to temporary disruption from the Beast from the East snowstorms, suggesting the central bank is still looking to raise the cost of borrowing again later this year.
“The underlying pace of growth remains more resilient than the headline data suggest,” said the BoE’s governor Mark Carney.
The Bank’s nine person Monetary Policy Committee (MPC) voted by a margin of seven to two to keep rates on hold at 0.5 per cent.
As recently as March financial markets were pricing in a 90 per cent probability of the BoE increasing rates to 0.75 per cent this month, guided by hawkish comments from Mr Carney. The reversal has provoked complaints from traders and City economists that the Bank has botched its communications strategy again.
“In our view this wasn’t a great advert for clarity in central bank communication,” said Allan Monks of JP Morgan.
Despite the Bank’s central view that the first-qaurter growth slump, when the economy is estimated to have grown by just 0.1 per cent, was a “temporary soft patch” rather than the beginning of a prolonged slump ahead of Brexit next year, most of the MPC said there was “value” in waiting to see whether this was actually true before raising rates again.
“The costs to waiting for additional information were likely to be modest, given the need for only limited tightening over the forecast period to return inflation sustainably to the target,” said the minutes of its latest meeting.
Ian McCafferty and Michael Saunders, two external members of the MPC, disagreed and argued that the economy was strong enough to handle an immediate rate hike, following the increase in the cost of borrowing to 0.5 per cent last November – the first rise since the financial crisis.
The Bank’s GDP forecast for the 2018 calendar year has been slashed from 1.8 per cent to 1.4 per cent. However, the Bank said this was entirely due to weak first-quarter growth, rather than any change in its underlying view of the economy’s prospects. Forecasts for the calendar year growth in 2019 and 2020 are unchanged at 1.7 per cent.
The Bank expects that the first-quarter GDP figure – the weakest in more than five years – to ultimately be revised up by the Office for National Statistics to 0.3 per cent, and for growth in the second quarter to bounce back to 0.4 per cent.
On inflation, the Bank’s projection over the next three years is slightly more benign, mainly due to the larger than expected fall in the Consumer Price Index growth rate this year relative to its expectation at the last inflation report in February.
The rate of inflation was just 2.5 per cent in March, while the Bank had pencilled in 2.9 per cent. Yet the Bank still sees “a small margin of excess demand” emerging in the UK economy by early 2020 due to a tightening labour market, with the official unemployment rate falling to just 4 per cent next year.
Financial markets currently foresee three rate rises from the Bank over that period, with the first occurring late this year or in early 2019.
“Were the economy to develop broadly in line with the May inflation report projections, an ongoing tightening of monetary policy over the forecast period would be appropriate to return inflation sustainably to its target on a conventional horizon,” the minutes said.
The Bank’s view that the first-quarter slump in growth was primarily related to weather is at odds with the perspective of the ONS, which sought to downplay the role of the snow when it released its first estimate earlier this month.
The ONS noted at that time that the steep drop in construction activity was spread over all three months of the quarter, not just the ones where snow fell, and that the underlying growth of the UK’s dominant services sector seemed to be down, relative to rates seen in 2017.
The Bank noted that the ONS’s preliminary first-quarter estimates were historically prone to revision, and similarly with quarters affected by bad weather. It also said that its preferred survey indicators pointed to underlying strength.
On Brexit, due to take place in March 2019, the Bank said that leaving the EU created “exceptional circumstances” for policymakers, in needing to balance monetary stability with support for the economy through a period of potential disruption.
“While the storms of February and March have given way to sunnier skies, the economic outlook for the UK remains clouded by Brexit uncertainties,” said Mr Carney.
“Despite the welcome agreement on a transition period, the terms on which the UK will trade with the EU beyond that period remain to be determined.”
The Bank’s underlying forecasts, relative to those from before the referendum in June 2016, still imply that Brexit has already taken a toll on the economy in the form of higher inflation and weaker output.
The UK’s annual GDP growth rate is well below that of the US and our European peers, despite a weakening of growth of the eurozone in the early part of 2018.
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