UK MPC more pessimistic about supply growth
Thursday, August 3, 2017 at 04:03PM
Simon Ward

A key take-away from the UK August Inflation Report is that the MPC has lowered its estimate of potential GDP growth to only about 0.4% per quarter. With the economy judged to be operating close to full capacity, a rebound in actual quarterly growth to above 0.4% could be sufficient to trigger an early rate hike.

GDP growth is now forecast at 1.7% in 2017 and 1.6% in 2018 versus 1.9% and 1.7% respectively in May. The downgrade partly reflects higher interest rates: the average level of Bank rate in 2018 implied by the market curve is 15 basis points higher than in May. Despite weaker growth, however, the three-year ahead inflation forecast is essentially unchanged – 2.22% versus 2.26% in May. Softer demand, in other words, is balanced by weaker potential growth.

The increased pessimism about supply-side potential is shown more clearly by inflation forecast based on an unchanged 0.25% Bank rate – the three-year ahead projection of 2.47% is up from 2.36% in May.

According to the latest policy statement, “GDP growth remains sluggish in the near term …” but “… picks up to just above its reduced potential rate over the balance of the forecast period”. GDP growth is projected at 1.8% at the end of the forecast so this suggests potential expansion of 1.6-1.7%, or about 0.4% per quarter.

The MPC expects quarterly GDP growth to remain at 0.3% in the third quarter before picking up slightly at the end of the year. A rebound to 0.5%, therefore, could be sufficient to persuade several more members to vote for an early hike.

Monetary trends are giving a more hopeful message for economic prospects: six-month growth of real narrow and broad money recovered significantly in June, reflecting a combination of stronger nominal expansion and a moderation of six-month inflation – see chart.

Article originally appeared on Money Moves Markets (http://moneymovesmarkets.com/).
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