The 7% unemployment threshold likely to be reached already in Q3 2015 – one year prior to the August forecast.
Growth forecast: Generally changes to the growth forecast have been small compared to the August IR. UK growth is likely to increase near term and top somewhere around 3% y/y in the first half of 2014. The pace of growth is thereafter likely to ease back somewhat in the second and third years of the forecast, as some of the initial boost, provided by the lifting of uncertainty and easing of credit conditions, moderates.
CPI Inflation forecast: In contrast revisions to the inflation forecast are significant. From previously expecting inflation to peak close to 3% in the first half of 2014, and thereafter falling back towards the 2% target by the end of the forecast horizon, the BOE projections now indicate inflation is likely to continue lower near-term. This means inflation probably will reach the target sometimes in 2014 and to stay below the inflation target for the reminder of the forecast period. In the report the BOE explains the lower than previously expected inflation by “broad-based weakness in goods and services price inflation, together with a number of specific factors including: the impact of recent falls in oil prices on petrol prices; utility price increases occurring later than expected; and a smaller contribution from university tuition fees this year”.
Unemployment forecast: The recent increase in demand has, however, also led to a narrowing of spare capacity within companies and to a further lower unemployment rate. The LFS unemployment rate fell to 7.6% in September, which is lower than expected three months ago. The MPC’s best collective judgement remains that productivity is likely to increase as the economy recovers, which will slow the decrease in unemployment. Nonetheless, according to the latest forecast the BOE now expect unemployment rate to reach the 7% threshold by Q3 2015 – which is one year earlier than in the August Inflation Report.
Monetary policy implications: Although unemployment at the 7% threshold only is a precondition to consider tighter monetary policy and not a promise, today’s revision of the unemployment forecast was a hawkish signal. On the other hand the inflation forecast was revised in a way that indicates that perhaps the bank could maintain a low rate despite unemployment in line with or below the 7% threshold value in a few years time. Uncertainty related to productivity growth also remains substantial and faster improvements may once again change the outlook for future unemployment. One should also consider what currently happens with UK house prices, which could trigger the knock-out condition related to financial stability well before low unemployment becomes an issue for monetary policy. Just as in other places rising house prices may, however, be handled by imposing macro prudential measures. Before that happens there is also the alternative to consider restricting current support programs related to the housing market, which appears to be the main reason for rising house prices in the UK. Although today’s report contained a slightly bullish message we maintain our view that low inflation will force the BOE to maintain current policy until Q4 2015.
FX implications: Although the new Inflation Report must be considered short-term positive for the GBP it does not change the medium-term and long-term view on the GBP. From a long-term perspective the GBP is around its fair values against the euro and the dollar. With inflation still above levels of trading partners and low productivity growth, a weak currency is still vital to compensate for weaker competitiveness and to achieve a rebalancing of the economy towards investments and external demand. Nevertheless, as the UK economy has improved substantially it is difficult to be very negative on the GBP although the data may have it difficult to beat high expectations, which should limit the upside potential.
SEB