Monetary Policy Summary

The Monetary Policy Committee (MPC) sets monetary policy to meet the 2% inflation target, and in a way that helps to sustain growth and employment. The MPC adopts a medium-term and forward-looking approach to determine the monetary stance required to achieve the inflation target sustainably.

At its meeting ending on 31 July 2024, the MPC voted by a majority of 5–4 to reduce Bank Rate by 0.25 percentage points, to 5%. Four members preferred to maintain Bank Rate at 5.25%.

The Committee has published an updated set of projections for activity and inflation in the accompanying August Monetary Policy Report.

Twelve-month CPI inflation was at the MPC’s 2% target in both May and June. CPI inflation is expected to increase to around 2¾% in the second half of this year, as declines in energy prices last year fall out of the annual comparison, revealing more clearly the prevailing persistence of domestic inflationary pressures. Private sector regular average weekly earnings growth has fallen to 5.6% in the three months to May, and services consumer price inflation has declined to 5.7% in June. GDP has picked up quite sharply so far this year, but underlying momentum appears weaker.

The Committee’s framework for assessing the medium-term outlook for inflation distinguishes between first and second-round effects. The MPC has been focused on second-round effects that capture more persistent inflationary pressures. The Committee continues to monitor the accumulation of evidence from a broad range of indicators.

The Committee expects the fall in headline inflation, and normalisation in many indicators of inflation expectations, to continue to feed through to weaker pay and price-setting dynamics. A margin of slack should emerge in the economy as GDP falls below potential and the labour market eases further. Domestic inflationary persistence is expected to fade away over the next few years, owing to the restrictive stance of monetary policy.

However, there is a risk that inflationary pressures from second-round effects will prove more enduring in the medium term. A stronger-than-expected path for demand, and structural factors such as a higher equilibrium rate of unemployment, could affect domestic wage and price-setting more persistently. Furthermore, the degree of restrictiveness of monetary policy could be less than embodied in the Committee’s current assessment.

In balancing these considerations, at this meeting, the Committee voted to reduce Bank Rate to 5%. It is now appropriate to reduce slightly the degree of policy restrictiveness. The impact from past external shocks has abated and there has been some progress in moderating risks of persistence in inflation. Although GDP has been stronger than expected, the restrictive stance of monetary policy continues to weigh on activity in the real economy, leading to a looser labour market and bearing down on inflationary pressures.

Monetary policy will need to continue to remain restrictive for sufficiently long until the risks to inflation returning sustainably to the 2% target in the medium term have dissipated further. The Committee continues to monitor closely the risks of inflation persistence and will decide the appropriate degree of monetary policy restrictiveness at each meeting.

1: The economic outlook

Chart 1.1: CPI inflation and CPI inflation excluding energy ^(a)

Footnotes

• Sources: Bloomberg Finance L.P., ONS and Bank calculations.
• (a) Energy prices include fuels and lubricants, electricity, gas and other fuels.

1.1: The conditioning assumptions underlying the MPC’s projections

As set out in Table 1.B, the MPC’s August projections are conditioned on:

• The paths for policy rates in advanced economies implied by financial markets, as captured in the 15 working day averages of forward interest rates to 22 July (Chart 2.7). The market-implied path for Bank Rate underpinning the August projections declines to around 3½% by the end of the three-year forecast period, compared with an endpoint of around 3¾% in the May Report.
• A path for the sterling effective exchange rate index that is around 2½% higher compared with the May Report. The exchange rate depreciates slightly over the forecast period, reflecting the role of expected interest rate differentials in the Committee’s conditioning assumption.
• Wholesale energy prices that follow their respective futures curves over the forecast period. Since May, oil prices have fallen, while gas futures prices are slightly higher. Uncertainty remains around the outlook for wholesale energy prices, including related to geopolitical developments.
• UK household energy prices that move in line with Bank staff estimates of the Ofgem price cap implied by the paths of wholesale gas and electricity prices (Section 2.4).
• Fiscal policy that evolves in line with UK government policies to date, as announced in Spring Budget 2024. The Government has announced that any changes in the stance of fiscal policy will be set out in the Budget on 30 October. These will be incorporated in the November Monetary Policy Report projections.

1.2: Key judgements and risks

1.2: Key judgement 1

Activity has picked up quite sharply so far this year, but underlying momentum appears weaker. Four-quarter GDP growth is expected to fall back a little next year in the Committee’s modal or most likely projection, but then increase again over the remainder of the forecast period, to around 1¾%.

Following weakness last year, UK GDP increased by 0.7% in 2024 Q1 and is now expected to have risen by 0.7% in Q2 (Section 2.3), compared with projections of 0.4% and 0.2% respectively in the May Report. Based on readings from business surveys, underlying momentum in activity is judged to be weaker than headline GDP growth. Quarterly GDP growth is expected to fall back to 0.4% in 2024 Q3 and to 0.2% in Q4, broadly consistent with the current signal from surveys.

The MPC’s August projections are conditioned on fiscal policy that evolves in line with UK government policies, as announced in Spring Budget 2024. After taking account of those plans and of the fading impact of past loosening measures, the stance of fiscal policy tightens over the forecast period. This pulls down on the Committee’s GDP growth projection beyond the near term.

Box C in this Report sets out the latest evidence on the transmission of higher Bank Rate to GDP through the domestic economy. Based on the average relationships over the past between Bank Rate and economic activity, Bank staff estimate that under the current market-implied path for interest rates, including its expected impact on broader financial conditions, most of the domestic impact of higher interest rates since the middle of 2021 on the level of GDP should be expected to have come through. The remaining impact is likely to drag further on the level of GDP in the near term.

Growth rates across advanced economies have generally converged at the start of this year (Section 2.1). UK-weighted world GDP increased by 0.5% in 2024 Q1 and is projected to grow at a similar pace for the rest of this year. In the August Report, the path of global growth is broadly unchanged from May, although the path of world trade is somewhat stronger during the middle of the forecast period reflecting developments in the euro area. Four-quarter UK-weighted world GDP growth is projected to rise to just over 2% in the medium term, slightly below its average rate in the decade prior to the pandemic (Table 1.D).

Overall, in the Committee’s August modal or most likely projection, UK four-quarter GDP growth is projected to fall back a little next year but then increase again over the remainder of the forecast period, to around 1¾% (Chart 1.2). That pickup in part reflects the fading negative impact on growth from past increases in Bank Rate and the downward-sloping market-implied path of forward interest rates, which begin to boost growth towards the end of the period. Notwithstanding the higher starting point, the pace of GDP growth in the August projection is broadly similar to the May Report over much of the forecast period.

Within the key private domestic expenditure components underpinning the August modal GDP projection (Table 1.D), household spending growth is expected to be only slightly positive this calendar year, although this in large part reflects the effect on the annual average of declines in consumption in 2023 H2. Spending is expected to increase steadily throughout the forecast period. The saving ratio is expected to peak at around 12% of household income in 2024 Q3, before falling back over the remainder of the forecast period. Following a period of pronounced weakness in 2023, housing investment is expected to grow moderately over the forecast period, stronger than expected in the May Report. Business investment is projected to grow by around 2% on a year earlier throughout much of the forecast period, a smoother profile than in May.

Chart 1.2: GDP growth projection based on market interest rate expectations, other policy measures as announced

Footnotes

• The fan chart depicts the probability of various outcomes for GDP growth. It has been conditioned on Bank Rate following a path implied by market yields, but allows the Committee’s judgement on the risks around the other conditioning assumptions set out in Section 1.1, including wholesale energy prices, to affect the calibration of the fan chart skew. To the left of the shaded area, the distribution reflects uncertainty around revisions to the data over the past. To the right of the shaded area, the distribution reflects uncertainty over the evolution of GDP growth in the future. If economic circumstances identical to today’s were to prevail on 100 occasions, the MPC’s best collective judgement is that the mature estimate of GDP growth would lie within the darkest central band on only 30 of those occasions. The fan chart is constructed so that outturns are also expected to lie within each pair of the lighter aqua areas on 30 occasions. In any particular quarter of the forecast period, GDP growth is therefore expected to lie somewhere within the fan on 90 out of 100 occasions. And on the remaining 10 out of 100 occasions GDP growth can fall anywhere outside the aqua area of the fan chart. Over the forecast period, this has been depicted by the grey background. See the Box on page 39 of the November 2007 Inflation Report for a fuller description of the fan chart and what it represents. The y-axis of the chart has been truncated to illustrate more clearly the current uncertainty around the path of GDP growth, as otherwise this would be obscured by the volatility of GDP growth during the pandemic.

In the modal GDP projection conditioned on the alternative assumption of constant interest rates at 5% over the forecast period, growth is weaker compared with the MPC’s projection conditioned on the declining path of market-implied rates.

The risks around the modal projection for GDP growth are judged to be skewed slightly to the upside over the first two years of the forecast period.

There are risks in both directions around the central projections for UK GDP and, for a given path of potential supply, around the output gap (Key judgement 2).

Internationally, the continuing risk of higher commodity prices and disruption to trade flows associated with developments in the Middle East could, alongside other significant geopolitical uncertainties, lead to weaker economic activity as well as greater external inflationary pressures (Key judgement 3). There remains a downside risk to global growth if domestic demand in China proves to be softer than expected. In the other direction, there may be a near-term upside risk to global activity if the recent resilience of advanced-economy labour markets were to persist, although that could also lead the stance of monetary policy to be more restrictive than otherwise. There is also uncertainty around the path of fiscal policy in advanced economies.

As discussed in Box C, there is some evidence that the impact of increases in Bank Rate on UK GDP has peaked a little earlier and at a smaller level than in the estimates underpinning the Committee’s August central projection. It is also possible that the equilibrium real interest rate has risen somewhat, such that the stance of monetary policy is less restrictive than assumed (see Box C in the February 2024 Report). All else equal, these risks could imply a stronger path of demand over the forecast period. The Committee’s forecast has for some time, however, incorporated a judgement to boost the expected path of demand relative to its standard determinants, and so it is also possible that a slightly faster or weaker monetary transmission mechanism in this rate tightening cycle rationalises part of this judgement and so is already captured indirectly in the August central projection. The Committee will continue to monitor closely the impact of past changes in Bank Rate.

Overall, the risks around the modal projection for UK GDP growth are skewed slightly to the upside over the first two years of the forecast period, allowing some of the recent momentum in domestic demand to continue for longer. This pushes up on the mean, relative to the modal, growth projections in the forecast. All else equal, this would also reduce slightly the degree of excess supply in the modal output gap projection (Key judgement 2) and hence increase domestic inflationary pressures slightly relative to the modal CPI projection (Key judgement 3).

1.2: Key judgement 2

In the Committee’s modal projection, aggregate demand and supply are judged to be broadly in balance currently, but a margin of economic slack is projected to emerge during 2025 and to remain thereafter, in part reflecting the continued restrictive stance of monetary policy. Unemployment is expected to rise somewhat.

Following a period in 2021 and 2022 in which the economy was operating with excess demand, aggregate demand and supply are judged to have been broadly in balance by the end of last year.

Given the upside news on GDP expected over the first three quarters of 2024, the Committee has considered carefully the extent to which this reflects developments in the balance of aggregate demand and supply. In general, the MPC’s approach is to calibrate its judgement on the starting level of the output gap based on a range of data and modelling approaches, including the extent to which news in GDP is consistent with developments in capacity utilisation, labour market tightness and other domestic inflationary pressures in the economy. In recent forecast rounds, GDP has first surprised to the downside and, more recently, to the upside (Annex 2). Indicators of utilisation and tightness have moved by much less across this period and, as a result, the Committee judges that the output gap has been more stable than movements in the GDP data might otherwise imply.

The MPC is continuing to consider the collective steer from a wide range of data to inform its view on labour market developments. As discussed in Box D in the May 2024 Monetary Policy Report and the June 2024 MPC Minutes, there remains considerable uncertainty around statistics derived from the ONS Labour Force Survey, making it more difficult to gauge the underlying state of labour market activity.

Based on a broad set of indicators, the MPC continues to judge that the labour market is loosening but that it remains relatively tight by historical standards (Section 2.3). Bank staff estimates suggest that the unemployment rate has been broadly stable over the past few quarters at a level somewhat below the LFS measure, which has risen to 4.4%. The number of vacancies and the vacancies to unemployment ratio have fallen further, the latter returning to around its pre-pandemic level. Underlying employment growth is estimated to have been stronger than LFS employment over the past few quarters, and to have been broadly in line with population growth. To the extent that businesses responded to weakness in GDP in the second half of last year by retaining their existing employees and using them somewhat less intensively, the recent strength of GDP growth has been accommodated without the need for businesses to increase headcount significantly.

Overall, the Committee judges in its modal projection that the margin of spare capacity in the economy is only slightly reduced at the start of this forecast compared with the May projection, and that demand and supply have remained broadly in balance so far this year.

The Committee has not adjusted its expectation of potential supply growth in this Report beyond the first half of this year. Four-quarter supply growth is projected to average around 1½% during the second and third years of the forecast period.

As in previous forecasts, demand growth is expected to be weaker than potential supply growth during 2025, such that a margin of economic slack is projected to emerge in the Committee’s modal projection. That in part reflects the continued restrictive stance of monetary policy, alongside the assumed tightening in the stance of fiscal policy. Aggregate excess supply is expected to reach around 1¼% of potential GDP by the end of 2025, broadly similar to the May Report. Thereafter, demand growth is expected to be slightly stronger than supply growth, such that the margin of economic slack starts to narrow gradually.

Uncertainty around LFS data notwithstanding, the unemployment rate is projected to rise somewhat during the second year of the forecast period, such that it exceeds the assumed medium-term equilibrium rate of around 4½% by the middle of next year. The unemployment rate reaches around 4¾% by the end of 2025 (Chart 1.3), broadly similar to the May Report, and remains around that level thereafter.

Chart 1.3: Unemployment rate projection based on market interest rate expectations, other policy measures as announced

Footnotes

• The fan chart depicts the probability of various future outcomes for the ILO definition of unemployment and begins in 2024 Q2. Although LFS unemployment data have recently been re-instated by the ONS, they are badged as official statistics in development and the LFS continues to suffer from very low response rates, which can introduce volatility and potentially non-response bias (see Box D in the May 2024 Monetary Policy Report). The fan chart has been conditioned on Bank Rate following a path implied by market yields, but allows the Committee’s judgement on the risks around the other conditioning assumptions set out in Section 1.1, including wholesale energy prices, to affect the calibration of the fan chart skew. The coloured bands have the same interpretation as in Chart 1.2 and portray 90% of the probability distribution. A significant proportion of this distribution lies below Bank staff’s current estimate of the long-term equilibrium unemployment rate. There is therefore uncertainty about the precise calibration of this fan chart.

In the modal projection conditioned on the alternative assumption of constant interest rates at 5% over the forecast period, the unemployment rate rises to a greater extent compared with the projection conditioned on market rates.

The risks around the modal output gap projection are judged to be skewed to the upside.

The Committee recognises the significant uncertainty around real-time estimates of the output gap, including the extent to which recent upside news in GDP could represent the re-emergence of a small margin of excess demand in the economy. All else equal, further positive surprises in activity data or signs of weakness in the supply side of the economy would suggest an upside risk around the Committee’s central projection for the output gap and hence greater domestic inflationary pressures (Key judgement 3). Set against that, external forecasters generally assume that there has been a greater margin of spare capacity in the economy recently.

Reflecting the continuing uncertainties around interpreting estimates from the LFS, there are risks in both directions around the recent path of the unemployment rate, and hence the outlook for unemployment and labour market tightness. The labour market could remain tighter or looser than assumed for a number of economic reasons, including the risks around the outlook for demand (Key judgement 1).

There is also continuing significant uncertainty around the MPC’s assumption for the path of the equilibrium rate of unemployment, news in which would, holding demand fixed, have implications for labour market tightness and inflationary pressures. The Committee made an upward adjustment to the medium-term equilibrium rate in the November 2023 Report, reflecting a greater degree of real income resistance following the terms of trade shock to the economy. It remains possible that the equilibrium rate of unemployment is even higher, consistent with more persistence in future wage growth. There has, however, been some evidence of a normalisation in the Beveridge curve relationship between the vacancies and unemployment rates that could imply a lower equilibrium unemployment rate if it were to continue.

Overall, the risks around the modal projection for the output gap are skewed to the upside at the start of and throughout the forecast period. This can be accounted for in part by the positive skew that has been incorporated into the GDP growth projection (Key judgement 1) but to a larger extent by the possibility of a higher medium-term equilibrium rate of unemployment pushing down on supply relative to demand. All else equal, this increases domestic inflationary pressures relative to the modal CPI projection (Key judgement 3).

1.2: Key judgement 3

CPI inflation is expected to increase to around 2¾% in the second half of this year as declines in energy prices last year fall out of the annual comparison, revealing more clearly the prevailing persistence of domestic inflationary pressures. The Committee continues to expect second-round effects in domestic prices and wages to take longer to unwind than they did to emerge.

Twelve-month CPI inflation was at the MPC’s 2% target in May and June, close to the projection in the May Report. The decline in CPI inflation since the start of this year has primarily reflected lower goods price inflation, alongside a small fall in services price inflation. Many indicators of household and business inflation expectations have normalised to around their 2010–19 averages (Section 2.4).

CPI inflation is projected to increase in 2024 Q3 and in Q4, to around 2¾%, similar to the May Report. This profile of inflation over the second half of the year is accounted for largely by developments in the direct energy price contribution to 12-month CPI inflation, which is projected to become less negative during Q3 and Q4 compared with Q2 (Chart 1.1). CPI inflation excluding energy is projected to be around 3¼% during the second half of the year, revealing more clearly the prevailing persistence of domestic inflationary pressures.

Four-quarter UK-weighted world export price inflation, excluding the direct effect of oil prices, was negative at the end of last year, but is since expected to have picked up (Section 2.1). Over the forecast period, the recent appreciation of the sterling exchange rate and its assumed path is likely to put some downward pressure on UK import price inflation, and over time on CPI inflation, relative to the May Report. Import prices are projected to fall by ¾% in 2024 and by 1% in 2025 (Table 1.D). The Committee has retained its judgement from the May Report that a greater-than-usual proportion of the pass-through of previous large-scale increases in import prices to consumer goods prices has occurred already.

The MPC has been monitoring closely indications of persistent inflationary pressures and resilience in the UK economy as a whole, including a range of measures of the underlying tightness of labour market conditions (Key judgement 2), wage growth and services price inflation.

Annual private sector regular AWE growth declined to 5.6% in the three months to May, in line with expectations in the May Report, and broadly in line with alternative indicators of wage growth. The Bank’s Agents report that pay settlements will average just over 5½% this year, with tentative expectations of lower settlements for 2025 (Box E). Private sector regular AWE growth is expected to slow further in the near term, to around 5% during the rest of this year, similar to the May Report.

Services CPI inflation has declined to 5.7% in June, higher than expected in the May 2024 Report. Services CPI inflation is expected to continue to ease only gradually over the course of this year, as wage growth weakens further.

In the August modal projection for CPI inflation, the Committee has maintained its broad judgement that second-round effects in wages and domestic prices will take longer to unwind than they did to emerge. There remains considerable uncertainty around the calibration of this judgement and a range of views among MPC members about the extent to which persistent pressures prove more enduring or continue to unwind as external cost pressures and inflation expectations have normalised (as set out in the subsequent risks sub-section). The Committee is also considering the interactions between the outlook for demand, the margin of spare capacity in the economy (Key judgement 2) and its judgement on excess persistence.

In the MPC’s modal projection conditioned on the market-implied path of interest rates as captured in the 15-working day average to 22 July, CPI inflation increases from the 2% target to around 2¾% at the turn of the year. Reflecting the continued restrictive stance of monetary policy and the emergence of a margin of slack in the economy (Key judgement 2), CPI inflation then falls back again, to 1.7% in two years’ time and to 1.5% in three years (Table 1.C and Chart 1.4). The August CPI inflation projection is similar to the May projection. Private sector regular AWE growth is expected to fall further during 2025 and reaches just under 3% towards the end of the forecast period, very similar to the May Report.

Chart 1.4: CPI inflation projection based on market interest rate expectations, other policy measures as announced

Footnotes

• The fan chart depicts the probability of various future outcomes for CPI inflation and begins in 2024 Q3. It has been conditioned on Bank Rate following a path implied by market yields, but allows the Committee’s judgement on the risks around the other conditioning assumptions set out in Section 1.1, including wholesale energy prices, to affect the calibration of the fan chart skew. If economic circumstances identical to today’s were to prevail on 100 occasions, the MPC’s best collective judgement is that inflation in any particular quarter would lie within the darkest central band on only 30 of those occasions. The fan chart is constructed so that outturns of inflation are also expected to lie within each pair of the lighter orange areas on 30 occasions. In any particular quarter of the forecast period, inflation is therefore expected to lie somewhere within the fans on 90 out of 100 occasions. And on the remaining 10 out of 100 occasions inflation can fall anywhere outside the orange area of the fan chart. Over the forecast period, this has been depicted by the grey background. See the Box on pages 48–49 of the May 2002 Inflation Report for a fuller description of the fan chart and what it represents.

In the modal projection conditioned on the alternative assumption of constant interest rates at 5% over the forecast period, CPI inflation is expected to fall below 2% from 2025 Q4 onwards. This path is lower than the Committee’s modal projection conditioned on market rates.

The risks around the modal projection for CPI inflation are skewed somewhat to the upside, reflecting more persistence in domestic wage and price-setting.

There are upside risks to inflation from a more enduring shift in domestic price and wage-setting behaviour, perhaps associated with a higher medium-term equilibrium rate of unemployment. The possibility of some upside risks to demand or other downside risks to potential supply could, via a smaller margin of spare capacity in the economy and given a relatively tight starting point for the labour market, also motivate a higher medium-term profile for domestically generated inflation.

Acting in the other direction, the continued unwinding of the past shocks to energy and other imported goods prices may moderate the extent to which employees and domestic firms will seek higher nominal pay and domestic selling prices to recover the reductions in real incomes that they have experienced in the past. As headline CPI inflation and short-term inflation expectations have fallen further, inflationary dynamics could therefore adjust as rapidly on the downside as they did on the upside.

On balance, the risks around the modal projection for CPI inflation are judged to be skewed somewhat to the upside throughout the forecast period, reflecting more persistence in domestic wage and price setting. In turn this can be attributed to the upside risks around the modal output gap projection in this forecast in part related to the possibility of a higher equilibrium rate of unemployment (Key judgement 2).

The positive skew pushes up on the mean, relative to the modal, inflation projections in the forecast. Conditioned on market interest rates, mean CPI inflation is 2.0% and 1.8% at the two and three-year horizons respectively.

The risks around the modal projection for UK CPI inflation from international factors are more balanced. Although they have been higher than expected, developments in Chinese export prices could pose a downside risk to UK inflation if past weakness were to re-assert itself, particularly if that were to encourage other countries to reduce their export prices as well. Although there has so far been a relatively limited impact on trade and oil prices from events in the Middle East, there is a risk of further intensification over a longer period. The possibility of greater trade fragmentation and increased trade restrictions could also push up on world export prices.

Table 1.D: Indicative projections consistent with the MPC's modal forecast ^{(a) (b)}

2: Current economic conditions