The most recent pronouncements from the Bank of England – the reflections of its governor, Mark Carney on the latest views of the Monetary Policy Committee (MPC), data on inflation and the bank’s report from its regional agents, have been marked by how subdued they are in tone.
The bank was clearly affected by the criticism that followed the EU referendum result and its involvement in what was described by the Leave campaign as ‘project fear’ prior to the vote.
In the calm manner adopted by his predecessor, Mervyn King, the current governor has provided a subdued analysis of very recent indications that the UK economy, while fundamentally sound, is facing significant challenges this year.
Inflationary pressures are building. The bank expects the current rate of CPI at 1.6% to rise significantly this year, peaking at 2.8% by the turn of the year. Its revised forecast for a 2017 annual growth in GDP of 2% surprised many analysts. The forecast that growth in 2018 would be slower at 1.75% did not.
These include a reaffirmation that the MPC will not hesitate to carry out its remit in controlling inflation – namely, using an increase in the bank base rate – when the CPI measure of inflation exceeds the agreed target of 2%. Given that Mr Carney suggests that inflation for February will reach 2% and that the MPC can only allow inflation to exceed the agreed target temporarily, the bank base rate could rise by a quarter of one percent by the middle of the year.
The MPC and the governor could not disguise their surprise that consumer confidence – and, consequentially consumer spending – had remained robust in the six months following the EU referendum. The bank fully expects consumer spending, particularly consumption based on cheap credit, to dampen over the next 12-18 months.
Perhaps the biggest concern, for the Chancellor as much as for the bank and the MPC, is the confidence of businesses in making investment decisions in 2017. The MPC report and the bank’s regional agents’ report suggests that investment confidence is subdued. This is especially concerning in relation to labour market dynamics. The slight increase in spending on recruitment by companies in Q3 and Q4 of 2016 was not the result of new job creation. Rather, it was the result of spending on increased incentives – either in the form of small pay rises or bonuses – by businesses to retain existing staff.
The bank seems to be relatively unconcerned by pressure on sterling and the decrease in the value of sterling against other major currencies on the exchange markets. Mr Carney seemed to suggest that sterling would find its own level in a post-referendum world.
While the outlook for the UK economy is far from bleak, particularly by comparison with the bank’s own forecasts in the period leading up to the EU referendum, the language being used by Mark Carney and the MPC provides several pointers to potential trouble ahead.
The strength of consumer spending has often surprised both the Bank of England and successive governments – not least in the period following the Nigel Lawson budget of 1987. Consumers are fickle and unpredictable. Significant increases in interest rates and a reduction in affordable credit market products will inevitably dampen consumer demand for products and services, just as a relaxing of regulation and easier access to credit can stimulate spending spikes. What is less certain is the effect of small, incremental changes in fiscal policy and direct monetary policy interventions.
Business investment is expected to be a quarter lower in three years’ time than the level predicted by the bank prior to the referendum. The MPC and Mark Carney are agreed that this will have consequences for productivity, wages and incomes.
The starkest warning of a slowdown in consumer confidence, and by implication consumer spending was included in Mr Carney’s assertion that:
“The tension between the current consumer strength and relative financial market pessimism to begin to be resolved over the course of this year.”
There is already evidence that the housing market is slowing as affordability, supply and uncertainty begin to affect consumer confidence in this sector.
What the recent pronouncements of the bank demonstrate is that the language now used is less alarmist than the predictive language deployed prior to the referendum, but the warnings inherent in the bank’s key forecasts are still there.