Press release

13 Dec 2019 London, GB

Bank of England/TNS survey shows dip in public’s UK near-term inflation expectations but longer-term expectations rise

Mixed news on inflation expectations for the Monetary Policy Committee to digest.

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  • Mixed news on inflation expectations for the Monetary Policy Committee to digest. The public’s inflation expectations for the year ahead dipped to 3.1% from 3.3% in the quarterly Bank of England/TNS survey carried out in November. Inflation expectations on a two-year horizon also edged down to 2.9% from 3.0%. However, inflation expectations on a five-year horizon rose back up to 3.6% after dipping to 3.1% in the August survey from 3.8% in the May survey.
  • The modest dip in inflation expectations on a one-year horizon and also on a two-year horizon was likely influenced by consumer price inflation moderating in recent months to its lowest level since November 2016.
  • It may also have been influenced by a “no deal” Brexit being avoided on 31 January. There were concerns that prices could be pushed up by a disruptive “no deal” Brexit that causes sterling to fall markedly and push up import prices.
  • The sharp move back up in inflation expectations on a five-year horizon is harder to explain, but it may well have been a correction after the particularly marked drop to a near three-year low in the August survey. There may also be uncertainties as to how Brexit will affect prices over the long-term.
  • We doubt that the latest inflation expectations survey will markedly influence the MPC’s current thinking on interest rates, although the slight dip in inflation expectations on one-year and two-year horizons modestly facilitates cutting interest rates. 
  • While the odds strongly favour the Bank of England keeping interest rates unchanged at 0.75% on Thursday after the December Monetary Policy Committee meeting, there will be much interest in the voting margin and the tone of the minutes of the meeting.
  • In particular, will any of the other seven MPC members join Michael Saunders and Jonathan Haskel in voting for an interest rate cut to 0.50%; and will the minutes come across as more dovish?
  • Developments since their November meeting may well have fuelled the MPC’s concerns over the current state of the UK economy. In particular, GDP growth of 0.3% quarter-on-quarter in the third quarter was less than the Bank of England had expected, and its anticipated growth of 0.2% quarter-on-quarter in the fourth quarter currently looks very challenging. Indeed, GDP was unchanged month-on-month in October causing the three-month/three-month growth rate to be flat. Meanwhile, the labour market has shown further signs of softening while consumer price inflation was well below its 2% target at 1.5% in October.
  • So latest UK economic activity, labour market and inflation developments seem overall to keep a future Bank of England interest rate cut very much on the cards. However, the Bank of England may well consider that the UK economy will benefit from a dilution (but far from ending) of uncertainties following the Conservatives achieving a substantial majority in the General Election and the now inevitable UK departure from the EU with Boris Johnson’s “deal” on 31 January – and that this warrants maintaining a “wait and see” stance on interest rates for now at least.
  • For now, we just about maintain the view that the Bank of England is most likely to keep interest rates at 0.75% through 2020. However, it is a close call and there is clearly a very real possibility that there could be a 25 basis point interest rate cut to 0.50% in 2020. 
  • If the UK economy fails to show clear signs of picking up in the early months of 2020, pressure will clearly mount on the Bank of England to trim interest rates to provide support. Pressure for lower interest rates could also mount if the economy continues to be hampered by concerns over the UK’s longer-term relationship with the EU and what will happen at the end of 2020 when the transition arrangement will be due to end.
  • The interest rate outlook could be influenced by the imminent appointment of the new Bank of England Governor to replace Mark Carney. While the new governor has just one out of nine votes on the MPC, he or she obviously can have a significant impact on the MPC’s deliberations. 

Howard Archer, chief economic advisor to the EY ITEM Club, comments:

“Mixed news for the Monetary Policy Committee (MPC) as the Bank of England/TNS quarterly survey for November shows the public’s inflation expectations for one-year and two-year ahead dipping but the five-year inflation expectations moving sharply back up after a substantial dip in the August survey.

“The modest dip in inflation expectations on a one-year horizon and also on a two-year horizon was likely influenced by consumer price inflation moderating in recent months to its lowest level since November 2016. It may also have been influenced by a “no deal” Brexit being avoided on 31 January. There were concerns that prices could be pushed up by a disruptive “no deal” Brexit that causes sterling to fall markedly and push up import prices.

“The sharp move back up in inflation expectations on a five-year horizon is harder to explain but it may well have been a correction after the particularly marked drop to a near three-year low in the August survey. There may also be uncertainties as to how Brexit will affect prices over the long-term.

“Specifically, consumer price inflation is seen at 3.1% over the next year. It had 3.3% in the August survey, which was the highest since November 2013 and up from 3.1% in the May survey. It is still above the long-term (1999-2019) average of 2.7%.

“Inflation is seen at 2.9% over a two-year horizon. It had been seen at 3.0% in both the August and May surveys. which was the highest since up from the highest level since November 2013. It is modestly above the long-term (1999-2019) average of 2.7%.

“Inflation is seen at 3.6% over a five-year horizon; It had previously fallen sharply to 3.1% in the August survey (the lowest since November 2016) from 3.8% in May, which had been the highest level since this series started in 2009; it is above the average of 3.3% over 2009-2019.  

“The survey showed consumers currently believe the inflation rate is 2.9%. It was seen at 3.1% in both the August and May surveys. The actual consumer price inflation rate stood at 1.7% in September (which would have been the latest available data when the survey was carried out during 1-5 November) and it subsequently dipped to 1.5% in October, which was the lowest level since November 2016.

“The survey also reveals that 39% of the public expect interest rates to rise over the next 12 months; this was the lowest since August 2016 and down from 43% in the August survey and 49% in the May survey.

“6% of the public expect interest rates to fall over the next 12 months; this had risen to 8% in the August survey from 4% in the May survey.

Preview of December meeting of Bank of England’s Monetary Policy Committee (MPC)

“While the odds strongly favour the Bank of England keeping interest rates unchanged at 0.75% on Thursday after the December Monetary Policy Committee meeting, there will be much interest in the voting margin and the tone of the minutes of the meeting. In particular, will any of the other seven MPC members join Michael Saunders and Jonathan Haskel in voting for an interest rate cut to 0.50%; and will the minutes come across as more dovish?

“The November MPC meeting saw two of the nine MPC members (Michael Saunders and Jonathan Haskel) voting for an immediate 25 basis point interest rate cut to 0.50%. This was the first split MPC vote on interest rates since June 2018. Saunders and Haskel took the view that – with the UK already having a modest but rising amount of spare capacity, the labour market showing signs of weakening, core inflation subdued and downside risks to the UK growth outlook stemming from the possibility of a weaker global economy and persistent Brexit uncertainties – extra monetary stimulus is warranted now to return inflation to its 2.0% target rate of a sustainable basis.

“The other seven MPC members took the view in November that interest rates of 0.75% currently remain appropriate as UK data had recently been broadly in line with expectations and a gradual recovery is anticipated during 2020 as consumer and business uncertainties are diluted by Brexit developments. They also noted the easier fiscal stance. However, they did acknowledge that if Brexit uncertainties become entrenched or global growth fails to stabilise, monetary policy may need to reinforce the expected recovery in UK growth and inflation.

“There was also a clear dilution of the MPC’s expectation that interest rates would need to rise over the medium-term. Previously and for an extended period, the MPC’s mantra had been that if there is a “smooth” UK departure from the EU, the UK would likely need a gradual and limited increase in interest rates to sustainably meet its 2.0% inflation target. This also assumed there is some recovery in global growth. In November, however, the MPC’s view was that if the UK economy develops in line with the Bank of England’s projections, some modest tightening of monetary policy might be needed to maintain inflation sustainably at its target rate.

“Developments since their November meeting may well have fuelled the MPC’s concerns over the current state of the UK economy. In November, the Bank of England estimated that the economy grew 0.4% quarter-on-quarter in the third quarter and it expected growth to slow to 0.2% quarter-on-quarter in the fourth quarter. This was seen resulting in overall GDP growth of 1.4% in 2019.

“However, third-quarter GDP growth came in below the Bank of England’s expectations at 0.3% quarter-on-quarter. Furthermore, the fact that GDP contracted in both September (0.1% month-on-month) and August (0.2% month-on-month) meant that the economy entered the fourth quarter on the back foot making growth of 0.2% quarter-on-quarter look difficult.

“Indeed, the economy got off to a poor start to the fourth quarter as GDP was only flat month-on-month in October which reduced the year-on-year growth rate to 0.7%, the weakest since March 2012. Furthermore, the three-month/three-month growth rate was flat. The economy looks to have had a somewhat mixed November. The purchasing managers reported services, manufacturing and construction activity all contracted in November, but there are signs (particularly from the BRC and Barclaycard) that retail sales picked up and were robust over Black Friday week. However, a critical factor will be how much strong Black Friday sales brought forward retail sales from December rather than increasing them.

“Additionally, the labour market is currently showing increasing signs of faltering with both employment and earnings growth coming off its June/July highs. Specifically, employment fell by 58,000 in the three months to September when the level of employment was 32.753 million compared to the peak of 32.811 million in the three months to June. Annual earnings growth eased back to 3.6% in the three months to September from the 11-year high of 3.9% in the three months to July.

“Meanwhile, consumer price inflation fell further below its 2.0% target rate in October as it weakened to 1.5% from 1.7% in September, which was the lowest rate since November 2016. Furthermore, price pressures further down the price chain were softer in October and benign, which bodes well for consumer price inflation remaining limited. Indeed, producer input prices were down 5.1% year-on-year in October (the largest annual decline since April 2016) as they dipped 1.3% month-on-month. The annual increase in producer output prices slowed to a more than three-year low of 0.8% in October (from 1.2% in September) as they edged down 0.1% month-on-month.

“So latest UK economic activity, labour market and inflation developments seem overall to keep a future Bank of England interest rate cut very much on the cards. Meanwhile, the global economy still looks to be struggling with the trading environment outlook uncertain.

“However, the Bank of England may well consider that the UK economy will benefit from a dilution (but far from ending) of uncertainties following the Conservatives achieving a substantial majority in the General Election and the now inevitable UK departure from the EU with Boris Johnson’s “deal” on 31 January – and that this warrants maintaining a “wait and see” stance on interest rates for now at least.

“A possible further loosening of fiscal policy in 2020/21 on top of the 4.1% increase in government spending (a 15-year high) may also fuel Bank of England caution on cutting interest rates – for at least the time being. 

“It is notable that in its November forecasts for the UK economy, while the Bank expected UK economic recovery to develop during 2020, it became significantly more downbeat about the medium-term growth outlook for the UK. This reflects a weaker global economic outlook and the expectation that the revised political declaration accompanying Boris Johnson’s withdrawal deal with the EU will lead to more non-tariff restrictions on trade with the EU than looked likely under Theresa May’s political declaration. This is seen impacting within the three year forecast horizon including customs checks, gradual regulatory divergence and more difficult market access for financial and legal services.”

Interest rate outlook

“For now, we just about maintain the view that the Bank of England is most likely to keep interest rates at 0.75% through 2020. However, it is a close call and there is clearly a very real possibility that there could be a 25 basis point interest rate cut to 0.50% in 2020. 

“If the UK economy fails to show clear signs of picking up in the early months of 2020, pressure will clearly mount on the Bank of England to trim interest rates to provide support.

“Pressure for lower interest rates could also mount if the economy continues to be hampered by concerns over the UK’s longer-term relationship with the EU and what will happen at the end of 2020 when the transition arrangement will be due to end.

“Meanwhile, consumer price inflation looks likely to stay below the Bank of England’s 2.0% target rate through 2020, thereby facilitating an interest rate cut by the Bank of England.

“The interest rate outlook could be influenced by the imminent appointment of the new Bank of England Governor to replace Mark Carney. While the new Governor has just one out of nine votes on the MPC, he or she obviously can have a significant impact on the MPC’s deliberations.”