Bank of England faces fresh embarrassment as it tears up its forecasts

https://www.theguardian.com/business/2017/feb/02/bank-of-england-forecasts-mark-carney-brexit-vote

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The Bank of England’s inflation report was supposed to be a dull affair. The City thought the quarterly health check of the UK economy would be a bit of a yawn.

Big misjudgment, as it happens.

The Bank dropped a bombshell by announcing rosy new forecasts showing that it expected the economy to grow by 2% in 2017. A growth upgrade by the Bank from November’s 1.4% forecast was anticipated following the strong performance of the economy in the second half of 2016. Such a big one was not.

The new forecasts are the latest embarrassment for the Bank. In August, it said the economy was likely to show virtually no growth in the third and fourth quarters of 2016. In fact, activity expanded by 0.6% in both and the momentum will carry over into the first half of 2017.

Last August, Threadneedle Street was pencilling in growth of just 0.8% in 2017 even after taking into account the impact of its emergency post-referendum cut in interest rates and the £60bn boost to quantitative easing. Now it says 2017’s growth will be only slightly slower than the 2.3% it was forecasting last May, when it assumed the referendum vote would go the other way.

The Bank says growth over the next three years will be 1% higher than it thought in November as a result of the boost provided to infrastructure spending by Philip Hammond in the autumn statement, a stronger global economy, higher share prices and easier credit conditions for consumers. Households will be prepared to run down their savings because they can borrow so cheaply.

The upshot of the faster growth is that the outlook for jobs has improved. The Bank has cut its forecast for unemployment in 2017 by half a percentage point to 5%, unchanged from its pre-Brexit estimate. By 2020, the Bank now thinks unemployment will be 1.6 million – 250,000 lower than expected three months ago.

In normal circumstances a combination of stronger activity and lower unemployment would mean higher inflation. Not so, says the Bank. It now thinks the economy can run at a lower level of unemployment – 4.5% rather than 5% – without wage pressures starting to build.

The forecasts come with some big caveats. Threadneedle Street is assuming that the higher imported inflation caused by the fall in the pound since the referendum is a one-off affair; that wage growth continues to be modest; and that consumer spending flags as prices in the shops go up.

The Bank’s nine-strong monetary policy committee has decided to leave interest rates unchanged at their record low of 0.25%. But the minutes of the meeting show that some members are starting to raise an eyebrow at projections showing a combination of stronger growth and above-target inflation in the months ahead.

That view is likely to be shared in the City. The Bank says the next move in interest rates could be in either direction, but the chances of a cut have been receding month by month. The odds are strongly in favour of the next move in borrowing costs being upwards, and sooner than previously expected.

Before the release of the inflation report the City was pencilling in the first rate rise in more than a decade for the tail end of 2018. That date has just been brought forward.