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Bank Rate maintained at 0.75%

1st August 2019

The Bank of England's Monetary Policy Committee (MPC) sets monetary policy to meet the 2% inflation target, and in a way that helps to sustain growth and employment. At its meeting ending on 31 July 2019, the MPC voted unanimously to maintain Bank Rate at 0.75%.

The Committee voted unanimously to maintain the stock of sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, at £10 billion. The Committee also voted unanimously to maintain the stock of UK government bond purchases, financed by the issuance of central bank reserves, at £435 billion.

Since May, global trade tensions have intensified and global activity has remained soft. This has led to a substantial decline in advanced economies’ forward interest rates and a material loosening in financial conditions, including in the United Kingdom. An increase in the perceived likelihood of a no-deal Brexit has further lowered UK interest rates and led to a marked depreciation of the sterling exchange rate.

Brexit-related developments, such as stockbuilding ahead of previous deadlines, are making UK data volatile. After growing by 0.5% in 2019 Q1, GDP is expected to have been flat in Q2, slightly weaker than anticipated in May. Looking through recent volatility, underlying growth appears to have slowed since 2018 to a rate below potential, reflecting both the impact of intensifying Brexit-related uncertainties on business investment and weaker global growth on net trade. Evidence from companies, up to the middle of July, suggests that uncertainty over the United Kingdom’s future trading relationship with the European Union has become more entrenched. The labour market remains tight. Annual pay growth has been relatively strong. Consumer spending has remained resilient. CPI inflation was 2.0% in June and core CPI inflation was 1.8%.

The Committee’s updated projections are set out in the accompanying August Inflation Report. They continue to assume a smooth adjustment to the average of a range of possible outcomes for the United Kingdom’s eventual trading relationship with the European Union. In the central projection, conditioned on prevailing asset prices, underlying output growth is subdued in the near term, reflecting more entrenched Brexit uncertainties. This means that a margin of excess supply persists over the first year of the projection. Thereafter, GDP is projected to accelerate to robust growth rates, reflecting a gradual recovery in global growth and firming UK domestic demand growth, driven in large part by a recovery in investment growth as uncertainties dissipate in line with the Brexit conditioning assumption. The acceleration in GDP results in a significant build-up of excess demand, to around 1¾% of potential GDP by the end of the forecast period. After falling in the near term, CPI inflation is projected to rise above the 2% target, as building excess demand leads to firmer domestic inflationary pressures. Conditioned on prevailing asset prices, CPI inflation reaches 2.4% by the end of the three-year forecast period.

These projections are affected by an inconsistency between the smooth Brexit conditioning assumption underpinning the forecast and the prevailing market asset prices on which the forecasts are also conditioned. These asset prices reflect market participants’ perceptions of the likelihood and consequences of a no-deal Brexit. If, as assumed, Brexit proceeds smoothly to some form of deal, market interest rates would likely rise and the sterling exchange rate would likely appreciate. A more consistent forecast would therefore have somewhat lower paths for GDP growth and CPI inflation.

Increased uncertainty about the nature of EU withdrawal means that the economy could follow a wide range of paths over coming years. The appropriate path of monetary policy will depend on the balance of the effects of Brexit on demand, supply and the exchange rate. The monetary policy response to Brexit, whatever form it takes, will not be automatic and could be in either direction. In all circumstances, the Committee will set monetary policy appropriately to achieve the 2% inflation target.

The MPC judges at this meeting that the existing stance of monetary policy is appropriate.

Assuming a smooth Brexit and some recovery in global growth, a significant margin of excess demand is likely to build in the medium term. Were that to occur, the Committee judges that increases in interest rates, at a gradual pace and to a limited extent, would be appropriate to return inflation sustainably to the 2% target.

Underlying UK GDP growth has softened to below-potential rates, reflecting weaker global growth as well as the impact of Brexit-related uncertainties. Growth is expected to remain subdued in coming quarters, as those uncertainties have intensified over the past few months and are assumed to remain elevated in the near term. CPI inflation is projected to fall temporarily below the MPC's 2% target over the second half of 2019 as energy prices decline. Conditioned on a smooth withdrawal of the UK from the EU, Brexit-related uncertainties are assumed to subside over the forecast period. Together with a boost from looser monetary conditions, the decline in uncertainties leads to a recovery in demand growth to robust rates. As a result, excess demand and domestic inflationary pressures build. CPI inflation picks up to materially above the MPC's 2% target by the end of the forecast period.

The MPC's projections are affected by an inconsistency between the asset prices on which they are conditioned — which reflect a higher perceived probability of a no-deal Brexit among financial market participants — and the smooth Brexit assumption underlying the central forecasts. In the event of a Brexit deal, sterling would be likely to appreciate and market interest rates and UK-focused equity prices to rise.

UK GDP growth has been more volatile than usual over the first half of 2019, largely due to developments relating to Brexit. For example, GDP growth of 0.5% in 2019 Q1 was boosted by companies building up stocks in order to mitigate the effects of a possible disruptive EU exit on 29 March. For the same reason, some firms in the car industry brought forward their usual summer shutdowns to April, and the resulting decline in production weighed on output in Q2. The unwind of the effect from stockbuilding will also have weighed on GDP growth in that quarter. UK GDP is expected to have been flat in Q2.

Abstracting from those temporary factors, the underlying pace of UK GDP growth appears to have slowed since 2018 to below its potential rate. Subdued underlying UK GDP growth reflects weaker global growth as well as the impact of Brexit related uncertainties. Those factors are expected to continue to weigh on growth in the near term, and to a greater extent than was expected at the time of the May Report. Globally, growth has slowed and is expected to remain at below-potential rates over coming quarters, partly reflecting the impact of an intensification of trade tensions. Domestically, firms’ perceived uncertainties related to the Brexit process have become more entrenched. Contacts of the Bank’s Agents report having become more uncertain about the economic outlook than they had been prior to the extension of the EU withdrawal deadline (Box 2). The proportion of respondents to the DMP Survey that expect uncertainty to be resolved in the near term has fallen significantly over the past few months (Section 2). Those uncertainties about the nature of the transition and the UK’s eventual trading relationship with the EU, and therefore the economy’s future path, will weigh on spending.