News: BoE struggles with productivity assumptions as policy remains on hold

Wed, 27 Nov 13

The Bank of England’s Monetary Policy Committee voted unanimously to hold quantitative easing (QE) at £375billion and interest rates at the record-low rate of 0.5%, according to minutes from its 6 and 7 November meeting.

Following its November Inflation Report released last week, the minutes re-iterated that the near-term UK outlook has strengthened, reflecting the positive tone of recent survey data. The minutes made further reference to the tentative increase in risk appetite in financial markets, the continuous increase in consumer confidence, and the improvement seen in the cost and availability of bank credit as factors likely to drive further growth in the near term.

On the downside, the committee expressed concerns over the sustainability of the economic recovery in light of falling real incomes as inflation continues to outpace earnings growth. This is expected to put a break on the rate of growth of consumer spending, which could in turn discourage business investment.

Danae Kyriakopoulou of the Cebr said: "The committee’s decision to keep monetary policy on hold was taken within the framework of its forward guidance policy, under which the Bank is committed to keeping interest rates on hold at least until the headline unemployment rate falls to 7.0%, or until one of the three knock-out conditions relating to the future path of inflation, inflation expectations, and financial stability are breached.

"According to its latest Inflation Report the Bank expects the headline unemployment rate to reach 7.0% in mid 2015, faster than previously anticipated. While this brings the Banks’s forecast closer into line with market expectations for an interest rate rise in early 2015, significant uncertainties surround the forecasts due to the difficulties in judging the future path of productivity. This is because the stronger the revival in productivity, the lower a need there will be for businesses to hire new workers. Labour productivity has already picked up in the first half of 2013, and this is expected to continue as the economic recovery strengthens further.

"Looking forward, Cebr expects unemployment reaching the 7.0% threshold by early 2015. This development would act as a trigger for the BoE to consider an interest rate rise then, but as the Bank is at pains to make clear, with enduring weakness in the UK, particularly as real incomes continue to fall, the Bank may see a need to continue supporting the recovery with loose monetary policy for longer. Expect the Bank to step up its communication offensive as unemployment edges down further."

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