UK retail spending has provided mixed signals for the economy but the bank of england remains upbeat about the next year or two
I have been asked to say a few words about the outlook for the British economy. Last year, the economy notched up growth of 2.7%, close to its average rate over the past decade.
That growth was underpinned by a recovery in consumer spending from its weakness the previous year, a revival in business investment and an expansion in exports buoyed by continuing robust growth overseas. Although the services sector remains the primary source of growth, we have also seen a welcome, if modest, recovery in the fortunes of manufacturing.
The Bank's Monetary Policy Committee believes that there are good reasons to expect this healthy performance to be maintained over the next year or two. First, while the recent data for retail spending have provided mixed signals, consumer spending seems likely to continue to grow at a moderate pace. Certainly, the three quarter percentage point increase in the Bank's official interest rate since last August will be a drag on spending, particularly that of highly-indebted households. But last year, higher domestic gas and electricity prices ate into consumers' purchasing power.
This year, the price of energy is set to fall rather than rise. That should boost family budgets, enabling them to spend more. And the continued buoyancy of house and equity prices should also provide a fillip to spending.
But the pace of growth of household spending will probably be rather less rapid than for much of the past decade. So the temperature on the High Street may nevertheless seem a little cool.
As far as investment goes, forecasting is always perilous because so much depends on the expectations and 'animal spirits' of those who run businesses. But surveys of investment intentions suggest that capital expenditure will remain buoyant in the near term.
Moreover, though profit margins have been squeezed by higher energy costs, subdued investment spending since the turn of the millennium and lower prices for capital goods mean that the rate of return on investment is nevertheless fairly high.
And corporate finances also look to be in reasonable shape. To be sure, the migration of labour-intensive production to Eastern Europe and Asia where labour is cheap means that some investments will no longer be taking place in this country.
But other parts of the economy have been expanding to fill the gap, particularly in services and high value-added manufacturing. So the need for other sorts of investments, particularly exploiting the possibilities of information technology, has simultaneously been increasing.
As far as export prospects are concerned, the world economy looks set for another year of healthy growth. The US economy slowed through last year on the back of a cooling housing market and a sharp decline in the building of new homes. But that slowdown does not appear to have spread to the wider economy, and growth there has recovered.
More importantly, as far as this country's trade is concerned, the euro area has picked up steam after a prolonged period of sluggish growth, and the signs are that this revival will be maintained. And, of course, the rapid development of China and India continues apace. It is true that sterling has risen noticeably since last spring and that will make it a bit harder for British exporters to benefit from continuing global expansion. But business surveys suggest that export orders have so far held up reasonably well.
All this might sound rather heartening. However, developments on the inflation front were somewhat less benign last year. And it is inflation that the MPC is charged with targeting, not the growth rate, unemployment, the exchange rate, house prices or anything else.
For much of the MPC's life, inflation has in fact been pretty close to the target given to us by the Chancellor - much closer than was expected when the framework was set up in 1997. Indeed, inflation has so far not deviated by more than one percentage point from the target, the point at which the Governor has to send an Open Letter of explanation to the Chancellor. But as I expect many of you will be aware, the Governor did come close to getting his pen out just a month ago, when consumer price inflation for December hit 3%. Yet a year earlier it stood at just 1.9%, a smidgen below the 2% target.
It is quite possible that inflation could be temporarily well below the 2% target in the latter part of this year. But that does not mean that the MPC can afford to relax about inflationary pressures. Just as the sharp upward movement in inflation over the past year may have exaggerated the pick-up in underlying inflation, so the prospective fall-back is likely to overstate the extent to which inflationary pressures have abated. The MPC needs to look through all this near-term volatility in order to judge whether inflation is on track to meet our target in the medium term.
We believe that CPI inflation is broadly on track to meet our 2% target in the medium term. However, there are uncertainties surrounding that prospect, on both the upside and the downside.
Those uncertainties are reflected in some differences of opinion within our committee and inevitably make it hard to know where interest rates will go next.
One of Huddersfield's most famous sons, Harold Wilson, once declared that he was an optimist, but an optimist who always carried a raincoat. The prospect that I have painted is a generally optimistic one. But central bankers, like business people, need to be prepared to deal with the unexpected. So even if it looks like a cloudless day, I can assure you that we will be carrying our raincoats, and that we will be ready to act as necessary in order to maintain the low and stable inflation to which we have now become accustomed.
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From 1 April 2019
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