The February 2025 Monetary Policy Report — and my vote - speech by Catherine L. Mann

Speech

I am delighted to be here at Leeds Beckett giving the economic prospects lecture, a feature here for 20 years now. I feel quite at home having been a tenured professor at the International Business School at Brandeis University outside Boston in the US and as an honorary professor at Alliance Manchester Business School. Plus, you will see over the course of today’s talk, how much my decisions are based on conversations with industry representatives and business leaders.

My plan for the next 20 minutes or so is to outline the projections released just last Thursday in the Monetary Policy Report. At that meeting, the Monetary Policy Committee voted with a 7-2 majority to cut Bank Rate by a quarter of a percentage point to 4½ percent and communicated that a ‘gradual and careful approach to the further withdrawal of monetary policy restraint was appropriate’. Along the way, I will discuss the disaggregated data that underpin my assessment of current and prospective economic and financial conditions which led me to vote for an ‘activist’ 50 basis point cut, but also to communicate in the minority voting paragraph of the minutes, that monetary policy ‘would need to remain restrictive for some time […] and Bank Rate would likely stay high given structural persistence and macroeconomic volatility.’

Let’s look at the projections from the Monetary Policy Report compared with the November forecast. Chart 1 shows that the MPC’s decision was taken against a backdrop of surprisingly weak economic activity in the second half of 2024 along with a modest further loosening in the labor market. Further out on the forecast horizon, GDP is expected to remain weaker than projected last November, with a somewhat higher unemployment rate. At the same time, inflation is projected to rise to 3.7% percent in the third quarter of this year before returning to a target-consistent trajectory that achieves 2% only in the fourth quarter of 2027 (Chart 2). In the near term especially, weaker activity combined with inflation expected to rise is a challenging, ‘trade-off inducing’ combination for a central bank.

Chart 1: Real GDP and unemployment rate in the November 2024 and February 2025 Monetary Policy Reports

Index (2022=100)^(a) and percent^(b)

Footnotes

• Sources: ONS and Bank calculations. Aqua lines show the forecasts for (a) real GDP and (b) the unemployment rate from the February 2025 Monetary Policy Report. The orange lines show the respective forecast from the November 2024 Monetary Policy Report.

Chart 2: CPI inflation in the November 2024 and February 2025 MPRs

Year-on-year percent changes

Footnotes

• Sources: ONS and Bank calculations. The aqua line shows the forecast for annual CPI inflation rates from the February 2025 Monetary Policy Report. The orange line shows the respective forecast from the November 2024 Monetary Policy Report.

Disaggregated data are key both for my assessment of the current and future demand conditions and for the consequent likely inflation trajectory. Underneath the near-term weakness in activity, market sector output is flat (Chart 3) and likely contracted in both of the last two quarters. Firms in the Decision Maker Panel had been expecting a recovery in sales which never materialised, so have continued, for the last 11 months, to revise down their actual sales volumes. Consumption, as measured, is expected to have been flat in the fourth quarter and has not firmed despite a continuing rise in real incomes, significant public sector wage awards last Autumn, the prospects of geographically widely disbursed NHS funding in the Budget, and higher population figures.

Chart 3: Change in measures of activity since 2022

Change in measures of activity since 2022 Q4^(a)

Footnotes

• Sources: ONS and Bank calculations. (a) Public sector output includes public administration and defence, education, and human health and social work activities. Market sector output equals total GDP excluding public sector output.

But, what about that inflation hump, which is more prominent than what was projected in November? In a speech last February I said, ‘Do not be seduced by the deceleration in headline inflation’. This February I say, ‘Do not be dismayed by the hump… yet’. Let’s take a look at the details to gauge potential risks (Chart 4). First, a significant part of the hump comes from administered and indexed prices such as water bills or phone bills and insurance. A further 0.1pp in the second year of the projection comes from the planned, yet oft-not implemented fuel duty increase. These are not driven by underlying domestic inflationary pressures. Second, and of greater relevance for monetary policy, about half of the hump comes from energy and food prices, which are salient for expectations formation (Anesti, Esady and Naylor, 2024) but, again, are less related to immediate domestically generated price pressures.

Chart 4: Decomposition of near-term CPI inflation

Projected contributions to cumulative change in CPI inflation from December 2024^(a)

Footnotes

• Sources: Bloomberg Finance L.P., Department for Energy Security and Net Zero, ONS and Bank calculations. (a) Data to December 2024. Component-level Bank staff projections from January to June 2025. The energy component includes fuels and lubricants and electricity and gas. The NICs bars show Bank staff estimates of the pass-through of the increases in employer NICs announced in Autumn Budget 2024 to headline CPI inflation. The other regulated/indexed component includes education, other transport services, other services for personal transport equipment and communication services. The water bills component includes water supply and sewerage collection. The food component is defined as food and non-alcoholic beverages excluding the estimated impact of the changes to employer NICs. The other goods component is defined as goods excluding energy, food and non-alcoholic beverages, water supply and the estimated impact of the changes to employer NICs on goods inflation. The other services component is defined as services excluding education, other transport services, other services for personal transport equipment, communication services, sewerage collection and the estimated impact of the changes to employer NICs on services inflation.

Wage settlements and the pricing power of firms will determine how much inflation outcomes will be driven by expectations as well as the one-off factors. I judge that both will face strong headwinds, including from the monetary stance. Let me go through some of the disaggregated data where I see risks differently from the central projections, how these informed my policy decision, and what that means for my preferred path for Bank Rate going forward.

The key risk is that the run-up in inflation for salient items like food and fuel causes another period of domestic, second-round inflationary effects like we have seen following the inflation caused by Russia’s invasion of Ukraine. A legitimate fear is that the energy and food components of the near-term inflation hump will be incorporated into inflation expectations and desired wage settlements going forward – and we do see an increase in inflation expectations by households and wages surprised on the upside in the three months to January.

However, I judge that this desire will not be realized this time around. Why? First, consider evidence from the distributions of the DMP survey for wage growth over the year ahead. Expected wage growth is fairly tightly centered around a target-consistent 3% for goods and business-services firms. For consumer-facing firms, currently the greatest probability mass (in aqua) is closer to 4%, which likely is not target-consistent. But the distribution is quite diffuse, suggesting a lack of conviction on exactly what will be the outcome or simply a greater dispersion in business prospects in the consumer-facing sector.

Chart 5: Distributions of 1-year ahead wage expectations from the Decision Maker Panel

Footnotes

• Sources: Decision Maker Panel and Bank calculations.

The likely slowing of wage growth is corroborated by the Bank’s Agents who, every year, survey a large sample of firms about pay settlements for the current year and their expectations for the next. This survey tells us that firms on average expect wage settlements to fall to below 4% in 2025. Chart 6 shows that these Agents forecasts have been quite accurate historically, which also supports the reading in the DMP survey.

Chart 6: Private sector wage settlements

Annual growth rates^(a)

Footnotes

• Sources: Bank of England Agents, Incomes Data Research, Incomes Data Services, Industrial Relations Services, Labour Research Department and Bank calculations. (a) The Agents’ pay survey diamonds shows respondents’ expected average pay settlements for a given year (as reported on the survey the year prior). Estimates are weighted by employment and sector. Latest diamond in purple shows respondents’ expected average pay settlements for 2025. The Bank of England private sector settlements database is informed by intelligence gathered from the Bank’s Agents, Incomes Data Research, Incomes Data Services, Industrial Relations Services, and the Labour Research Department. Companies were asked to state their average UK pay settlement for each year and their expected average UK pay settlement for 2025. Private sector pay settlements are a 12-month average based on monthly data.

Second, I judge that the current and likely continued weak demand conditions will lead to a further loosening of the labor market which tend to follow non-linear dynamics.^{footnote [1]} Thus, even if near-term inflation expectations firm on the back of the inflation hump, these factors likely will restrain pass-through to wages and prevent second-round effects from setting in.

Already, the labor market has all but stopped adding jobs with employment nearly flat (Chart 7). Vacancies are now below their pre-Covid level and the vacancies-to-unemployment ratio which we have often used to proxy for ‘tightness’^{footnote [2]} is now below the level that Bank researchers consider to be consistent with a balanced labor market (Chart 8).^{footnote [3]}

Chart 7: Measures of employment growth

Three-month-on-three-month growth rates^(a)

Footnotes

• Sources: Bank of England Agents, HM Revenue and Customs, KPMG/REC/S&P Global UK Report on Jobs, Lloyds Business Barometer, S&P Global, ONS and Bank calculations. (a) Bank staff’s indicator-based models of near-term employment growth use mixed-data sampling (MIDAS) techniques (Daniell and Moreira (2023)). Latest data are three months to November for LFS employment and December for HMRC RTI employment. Quarterly estimates of underlying employment growth extend to 2024 Q4.

Chart 8: Labor market tightness

Vacancies to unemployment ratio and estimated equilibrium values^(a)

Footnotes

• Sources: AA/WARC Expenditure Report, ONS and Bank calculations. (a) The equilibrium V/U ratio is estimated using an error-correction model over the period 1982–2023. The real cost of vacancy posting and hourly labour productivity are included as long-run determinants for the level of vacancies. The model also includes controls for short-term movements in these variables. Further technical details will be available in a Bank Underground post (Stelmach et al. (forthcoming)). The final data points for both series in the chart are 2024 Q3.

Additionally, since our last forecast in November we have learned more about the likely response of firms to overall economic conditions, recent increases in the National Living Wage, and salient aspects of the Autumn budget such as the increase in employer National Insurance contributions. As we have discussed in the recent MPRs, firms’ margins of adjustment include wage growth, headcount and hours, prices, profits, and productivity-enhancing innovations.^{footnote [4]}

Chart 9 shows the reaction of firms in the DMP by their reported margin of adjustment of employment growth to rising NICs. Those firms who reported reduced employment growth as a margin of adjustment^{footnote [5]} revised down their employment growth expectations significantly (solid versus hollow orange diamonds in Chart 9) following the Budget announcement. Cost increases more generally on firms, particularly smaller ones, expose cash flow vulnerability, with 39% of respondents to the BICS survey^{footnote [6]} holding cash reserves sufficient for less than 4 months. Research suggests that such cash flow vulnerability is associated with job shedding, which may become more apparent as COVID support policies run off.

Chart 9: Employment growth in the Decision Maker Panel tightness

Annual employment growth and expectations for the year ahead

Footnotes

• Source: Decision Maker Panel and Bank calculations. Notes: Lines show realised employment/wage growth, diamonds show expectations one-year ahead. Hollow diamonds show the expectations from the three months to July 2025 and October 2025 respectively (surveyed pre-budget), and the solid diamond show the expectations in the three months to January 2026 (surveyed post-budget).

Finally, as I have said before, in the end, it is firms’ pricing decisions that determine aggregate inflation outcomes. What evidence is there on firms’ pricing power? In the data, I have focused on the most income and price elastic categories of products as the leading indicators of how consumer behavior can discipline firms’ pricing strategies. In the latest disaggregated data, the decelerations in these categories such as catering, culture, and hospitality have become more systematic. Even more granularly (some 1.25 million observations per year), the balance of price increases and decreases in the CPI microdata for non-energy goods and for services (Chart 10) has nearly returned to their pre-Covid levels, indicating to me that the risk of embedded inflationary behaviors has diminished sufficiently to warrant a reduction in monetary policy restrictiveness.

Chart 10: Share of prices changing in CPI microdata

Footnotes

• Source: Bank calculations following Brandt, Burr, and Gado (2024). Notes: Solid lines show the share of item-level prices changing between months, seasonally adjusted using X13. Dotted lines show their respective 2011-2019 averages. Latest observation: December 2024.

Looking beyond 2025, I judge that the dynamics of soft sales volumes, already observed for a year, will be accentuated as household savings rates remain high, both as an ongoing precaution against volatility in purchasing power and then also on account of heightened unemployment concerns. This likely soft consumption profile will constrain firms’ pricing power and will moderate pass-through of costs.

Is this a much different assessment from the quarter-point vote of the majority along with a gradual removal of restrictiveness? A vote is not just about the monetary policy response to current conditions, it is also about risk management and communication, including of the longer term.

Unlike the majority of the committee or the other dissent, this was my first vote for a cut in Bank Rate during this cycle. Over the course of my time as an MPC member, I’ve contrasted my monetary policy approach with the received wisdom of gradualism as the optimal policy strategy. In its original formulation going back to Brainard (1967), moving rates gradually is argued to give the policymaker time to learn about the monetary transmission mechanism when it is especially uncertain. However, the main uncertainty that I have worried about is the propagation of shocks into non-linear and asymmetric dynamics in the inflation process which, in my view, requires a different risk management strategy.^{footnote [7]} I call this strategy ‘activism’, even if that sometimes means standing pat with a hold.

At this meeting, the incoming data from the disaggregated pricing behaviors and the survey evidence pointing to the potential for a non-linear adjustment in the labor market which would accentuate weak demand, allowed me to look through the inflation hump, and vote to cut by 50 basis points.

However, beyond the specifics of this vote, as discussed in my Great Moderation speech to the Society of Professional Economists in November, the activist strategy aims to increase the signal-to-noise ratio that any Bank Rate change might send about the desired stance of monetary policy. In looking at financial conditions indices, for example the one in Chart 11, it seemed to me that the two quarter-point cuts last year had not appreciably loosened financial conditions. Indeed, the projections in the February Monetary Policy Report were conditioned on a path for Bank Rate that is above four percent for the entirety of the forecast horizon which, given my assessment of the UK outlook, was not consistent with achieving the 2% target sustainably.

Chart 11: A measure of financial conditions in the UK

Footnotes

• Source: Bloomberg Finance L.P, ICE, Moneyfacts, Refinitiv Eikon from LSEG, Tradeweb and Bank calculations based on Burr (2023). Latest observation: December 2024.

As it has turned out, between the closing of the 15-day window for the conditioning assumption for the February report and prior to the vote, the market-implied path for Bank Rate had already loosened some 30 basis points at the 2-year horizon most relevant for monetary policy transmission. That’s a lot of re-assessment of the appropriate monetary stance; or maybe something else is moving the market’s expectations of Bank Rate.

Both market intelligence from our Market Participants Survey (MaPS)^{footnote [8]} and model-based decompositions of asset prices^{footnote [9]} suggest that it is spillovers, particularly from the United States, that have dominated market pricing of the Bank Rate path, less so UK economic conditions. Financial market volatility^{footnote [10]} coming importantly from international spillovers blurs the signal about the desired stance of monetary policy as well as tempers the transmission of monetary policy to the domestic economy. To ‘cut through the noise’, bolder action and more explicit communication of current stance and future path are needed.

It is not just the immediate policy decision that needs to be communicated. Providing insights on the future path matters for the activist policy maker. Notwithstanding the 50 basis point cut now, structural impediments to achieving the target on a sustained basis^{footnote [11]} are not yet fully purged. The activist policymaker needs to maintain policy rate discipline and restrictiveness even after this immediate decision. This ensures that, as we move through the inflation hump, expectations remain anchored both in the near and longer term.

Finally, as I outlined in my speech in Vilnius last September, observed inflation volatility, even if two-sided, likely requires higher Bank Rate than otherwise because the MPC will have to lean against the combination of larger or more prevalent shocks and downwardly rigid wage and price responses. Therefore, I expect that Bank Rate will average well above the nominal equilibrium rate implied by the estimates set out in the August 2018 Inflation Report.^{footnote [12]} I note that respondents in our Market Participants’ Survey have been consistent in putting this longer-run average at about 3-3½ percent.^{footnote [13]} I’m more likely at the higher end of that range.

To conclude, as an activist policy maker, I chose 50 basis points now, along with continued restrictiveness in the future, and a higher long-term Bank Rate to 1) ‘cut through the noise’, 2) anchor expectations through the inflation hump, and 3) acknowledge structural impediments and macroeconomic volatility in longer term.

The views expressed in this speech are not necessarily those of the Bank of England or the Monetary Policy Committee.

Acknowledgments

I would like to thank, in particular, Lennart Brandt and Natalie Burr for their help in the preparation of this speech, as well as Andrew Bailey, Jamie Barber, Phil Bunn, Fabrizio Cadamagnani, Alan Castle, Jenny Chan, Neha Jain, Josh Martin, Krishan Shah, and Katie Taylor for their comments and help with data and analysis.