Higher growth and lower inflation but current policy stance seems to remain
Growth forecast: According to the Committee’s judgment, both demand and effective supply look set to pick up gradually over the next year, supported by past asset purchases, a further easing in credit conditions helped by the FLS extension, and a gradual fading of the impact of the financial crisis on household and business spending. Compared to the Feb IR forecast the change in the growth forecast is quite small. Still the biggest risks to the growth forecast steams from outside UK although the demand side of the domestic economy is uncertain.
Inflation forecast: As we suspected the BOE revised its inflation forecast lower. Inflation is expected continue higher in coming months before it peaks just above 3% in H2 2013. It will thereafter edge lower towards the 2% inflation target by the end of the forecast horizon as external price pressures fade. Domestic cost pressure is expected to remain weak with some support from a revival in productivity growth.
Monetary policy implications: With a small upward revision to growth while inflation was revised lower and now projected to fall back towards the target within the forecast horizon, the May inflation report was a bit more optimistic on the UK outlook. While better than expected growth potentially reduces the need for further QE if it materializes, lower inflation opens up for the possibility of more bond purchases if growth would fail to recover in line with expectations. However, short term I really can’t see how the new projections could change the near term monetary policy outlook as the majority in the MPC probably will be hard to convince that further QE would have any significant impact. Perhaps that could change as Carney enters the office in July, but most likely not before. Moreover according to comments by King he said that with current inflation the room for maneuver is limited but he did not rule out the possibility for further easing by for instance the introduction for negative rates. However, King also said there are good reasons not to use that tool. On the other hand King said that if the economy improves it may allow quicker rate increases than what the market perhaps expects. All-in-all it appears monetary policy will remain unchanged for a long time and the next change to policy will probably be the introduction of new measures for forward guidance, which will be outlined in the August inflation report.
FX implications: From a long-term perspective the GBP is around its fair value against the euro and the dollar. With inflation above trading partners and low productivity growth it appears the only way to compensate for weaker competitiveness and to achieve a rebalancing of the economy towards investments and external demand is by a weak currency. Hence, to us the fundamental outlook indicates there is more scope for GBP weakness going forward, although it seems less probable monetary policy will contribute to that.
SEB