The MPC revised up its growth forecast significantly while making little change to its inflation forecast and retaining a neutral policy stance – contrary to the expectation here of a shift to a tightening bias.

How was the MPC able to raise forecast GDP growth over 2017-2019 by 0.8 percentage points without lifting its longer-term inflation numbers? Mainly by raising its estimate of labour market slack: the “equilibrium” unemployment rate is now judged to be 4.5%, down from 5% in November. The MPC claims that lower-than-expected wage growth over 2014-16 warrants this change of view. Recent wage news, however, has surprised to the upside – annual earnings growth is estimated to have been 2.75% in the fourth quarter of 2016, up from a projected 2.5% in November. Why is the MPC changing its assessment now, rather than three months ago, or earlier?

Based on the forecasts, a fair description is that the MPC is now pursuing a policy of unemployment- rather than inflation-targeting. The unemployment rate is projected to be stable at or below 5.0% through 2019, while inflation remains above 2.5% until mid-2019, returning to the 2% target only in 2020. The MPC evidently regards sustained above-target inflation as a “price worth paying” to prevent a temporary rise in unemployment from its current level.

While the policy statement indicates that rates could move in either direction, there is a hint of hawkish dissent in the minutes, according to which all members agreed that “there were limits to the degree to which above-target inflation could be tolerated”, while, for some, “the risks around the trade-off embodied in the central projection meant they had moved a little closer to those limits”.  

Governor Carney has held the line for now but may have to yield ground by May if – as expected here – the economy continues to grow respectably in early 2017 while inflation and wage growth rise by more than the MPC forecasts.