Stronger business investment and the ongoing global recovery will ensure economic growth this year remains solid, even as households face the biggest real income squeeze since 2013, according to the Bank of England.
Bank policymakers trimmed their forecast for UK growth to 1.9 per cent this year, down from 2 per cent in its February projection, the Telegraph reports.
While the slight downgrade was driven by a slowdown in consumer spending, growth is still expected to be higher than 2016, when the economy expanded by 1.8 per cent.
Officials voted 7-1 to keep interest rates on hold at 0.25 per cent in May as they warned that the fall in the value of the pound since the Brexit vote last June was likely to push real post-tax household income growth to zero later this year – representing the biggest squeeze in four years.
The Bank’s quarterly Inflation Report also slashed its forecast for wage growth to 2 per cent this year, from a previous projection of 3 per cent as it predicted a year of falling real wages.
Inflation, as measured by the consumer prices index (CPI), is expected to have jumped to 2.7 per cent in April from 2.3 per cent in March.
It is forecast to peak just below 3 per cent this year, before easing gradually to 2.2 per cent in 2019.
Mark Carney, the Governor of the Bank of England, warned that it would be a “more challenging time” for British households as prices for goods and services rose at a faster pace than wages.
The Monetary Policy Committee (MPC) that sets interest rates said a “slowdown appeared to be in train”. It expects growth to remain around the “moderate pace” of between 0.3 per cent and 0.4 per cent per quarter for the rest of the year.
However, Mr Carney said that it was also important to put the household squeeze in context. The unemployment rate is projected to drop to its lowest since 1975 by the end of the decade, while Mr Carney said measures of consumer confidence remained steady.
“The context is the economy is still growing solidly, the economy is still creating jobs, wages are still growing and we expect the pace of wage growth is going to accelerate as this year progresses and certainly into 2018 and 2019,” he said.
The Bank said the brighter global outlook and better incentives to invest were likely to support growth in the coming years as it revised its growth forecasts up slightly for 2018 and 2019 to 1.7 per cent and 1.8 per cent, up from 1.6 per cent and 1.7 per cent respectively.
Bank policymakers highlighted that the solid outlook for growth and jobs was conditioned on a “smooth” Brexit, amid signs that companies were already constraining pay rises due to uncertainty surrounding the UK’s future relationship with the European Union.
Minutes of its latest meeting said the “more upbeat global outlook” and the fall in sterling since the EU referendum had improved the incentives for exporters to renew and increase capacity.
Business investment is now expected to be positive this year, while policymakers more than doubled their forecast for business investment next year to 3.25 per cent, from a previous projection of 1.25 per cent.
Its latest Inflation Report said: “Weaker consumption this year is largely balanced by rising net trade and investment. The outlook for global activity continues to improve.”
Mr Carney said signs of more balanced growth were “welcome”, but cautioned that businesses remained cautious about spending money amid uncertainty surrounding the UK’s future relationship with the EU.
The Governor described the upgrades to its export growth and business investment projections as “relatively modest” given the scale of the fall in the value of the pound and the strength of global economy.“
Certainly it’s more welcome to have more balanced growth … but it’s not booming,” he said.
Kristin Forbes, an external member of the Bank’s Monetary Policy Committee (MPC) voted to raise interest rates for the second straight month.
Policymakers also pushed back against the idea that rates would remain on hold well beyond the Brexit date of 2019.
It said the risk of the economy overheating was likely to increase towards the end of the decade, when unemployment is projected to fall to its so-called “natural rate” of 4.5 per cent.
“On the whole, the Committee judged that, if the economy followed a path broadly consistent with the May central projection, then monetary policy could need to be tightened by a somewhat greater extent over the forecast period than the very gently rising path” implied by a forecast based on just one rate rise this decade,” policymakers said.
However, sterling fell against the dollar and euro after policymakers surprised the market by revising down their medium term inflation expectations, partly due to the mild rebound in sterling since February.
The Bank stressed that many uncertainties remained, with a “significant increase in wage growth” still needed in order for domestic costs – and therefore interest rates – to rise.
Economists said this suggested the Bank was more likely to keep interest rates on hold as negotiations with Brussels on the UK’s exit from the EU progress.
“We stick with our view that the economic data will begin to roll over in response to Brexit uncertainty before the MPC gets a chance to raise rates – and that it might be another two years or more before the Bank can tighten,” said analysts at Nomura.
There had been speculation that Michael Saunders, another external member, could join the MIT professor in voting for higher rates following hawkish comments earlier this year, though the former Citi economist voted with the majority to keep rates on hold. The MPC also voted unanimously to keep its stockpile of asset purchases at £435bn.
Markets currently expect two rate rises before the end of the decade.
The MPC noted that both regular and total pay had been weaker than policymakers expected in February.
“It is possible that some of the recent weakness is a consequence of companies’ uncertainty about the outlook, with some unwilling to raise wages at a faster pace until they have more clarity about their future costs and markets,” the Bank said.
It added that other costs such as pensions auto-enrolment and the introduction of the Apprenticeship levy would also lead to subdued pay settlements, although the MPC said these factors were likely to be temporary.
The Office for Budget Responsibility (OBR) expects real earnings to fall in the second half of this year before picking up again.
Bank of England governor Mark Carney has reiterated his expectation that the bank will raise interest rates soon.
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