Easing of inflationary pressure in the UK economy is shown in chart three. While levels remain elevated, measures of underlying services price inflation have continued to diminish. This has happened as pressures from non-labor input costs have faded. So persistence in wage growth is now the main driver of continued high levels of services price inflation.
My second key message is that a small margin of slack has opened up in the UK economy and we expect it to widen over the next couple of years. Heightened uncertainty, weak productivity growth, and the continued restrictive stance of monetary policy have all been weighing on GDP growth recently. Businesses have been cautious about investing. That's the message we're getting.
And while real household incomes have risen quite strongly, consumption has not followed suit. This weakness in demand has coincided with continued weakness in the potential supply capacity of the UK economy. Productivity growth has been weak. Nevertheless, labor market developments, survey indicators of capacity utilization, and statistical estimates all suggest that weaker demand has led to a small margin of economic slack opening up.
Looking through data volatility, we expect underlying GDP growth to remain subdued in the near term before economic activity starts to pick up later this year as household spending and business investment recover, supported by a downward path for interest rates. We expect housing investment to strengthen too.
Assuming potential productivity recovers some of its recent weakness, that pickup in GDP growth will still probably go hand in hand with a wider margin of slack. This takes me to the third key message. An emerging margin of slack in the UK economy should act against any remaining persistence in domestic wage and price setting to return inflation to the 2% target sustainably.
A normalization in wage growth is particularly important to ensure that services price inflation continues to fall back to levels consistent with the 2% target for headline consumer price inflation. Now this process still has some way to go. Annual private sector regular average weekly earnings growth was 5.9% in the three months to February, having risen in the second half of last year.
Now that level in February was slightly lower than we'd expected in the last monetary policy report. However, and as chart four shows, underlying measures estimated by the bank staff have been more stable and point to a slightly lower rate of wage growth. And as we look ahead over the course of this year, we expect wage growth to moderate with a loosening in labor market conditions.
This is supported by forward-looking indicators. The bank's latest decision-maker panel survey suggests that wage growth will be about 4% for the year ahead. That's the yellow diamond on this chart. And the bank's agents point to average pay rises for 2025 being between 3.5% and 4%. That's the purple diamond.
With a continued easing in labor as well as non-labor costs, further declines in services price inflation will support a gradual return of headline inflation to the target as we look beyond the near-term increase. Now, as shown in chart five here in our baseline projection conditional on the market-implied path for bank rate, inflation gradually falls from later this year to reach around the 2% target within two years' time.
My fourth key message is about the global economy. New tariffs and elevated trade policy uncertainty weigh on global activity. We expect global trade prices to be materially weaker, particularly in China. The US administration has made a series of announcements with significant changes to tariff policies. Some of its trade partners have responded. Volatility in financial markets has accompanied these announcements.
Slower growth in the global economy is likely to reduce the demand for our exports and impact economic activity here in the UK. That reduction in external demand will also work to reduce inflationary pressures in the economy. But while the impact of what we have seen so far is likely to push inflation down somewhat, the overall impact on inflation remains uncertain.
On the one hand, lower US demand for global exports, particularly from China, could lead to lower global export prices and hence lower prices in the UK, reducing inflationary pressure further. On the other hand, higher costs in the global supply chain as intermediate inputs are subjected to tariffs or because of disruptions could push up on prices.
And while sterling has appreciated in recent weeks, easing inflationary pressures, global exchange rates can shift in response to trade policy news and the evolution of global risk sentiment. Although they understandably dominate the headlines, it's important to remember that global trade policies and how they affect the UK economy is only one source of risk to the outlook for inflation in the UK.
Let me say just a word about the news obviously that has been coming out in the last few hours about the prospects of a US-UK trade agreement. We obviously follow this very closely. We haven't been briefed, so I'm speaking without knowing the content of the agreement, just to make that clear. That's as I would expect. But we do now have news that suggests there will be an announcement and we welcome that news. I very much welcome it and I think it's very well done to those involved. And the reason for saying that is that it will help to reduce uncertainty and that's important as you will see in the context of what we've said today.
The UK is though a very open economy. So the UK is also affected by the way in which trade policy and tariffs affect obviously other economies. That is in other words the tariff measures that have been taken in respect of other economies. So I say that because I hope the UK agreement, if it is indeed announced this afternoon, will be the first of many. This will be good news all round, including for the UK economy. But it is excellent if it is indeed the case this afternoon that the UK is leading the way. And I do congratulate both those in the UK who are involved and those in the US too.
So the MPC is alert to a range of risks in both directions. Domestic inflationary pressures could persist for longer than we expect despite the progress we've made, or they could ease more quickly as the margin of slack widens. The balance between supply and demand in the UK economy and how it will develop over the forecast horizon also remains very highly uncertain.
We need to watch very carefully for any signs that the near-term increase in inflation could lead to additional second-round effects on wage and price setting, although that's not our central assumption, but also for any further weakening in demand, which would reduce inflationary pressure. Now, with this in mind, in the monetary policy report, we present two scenarios in addition to a baseline projection for activity and inflation to illustrate some of these risks.
In one scenario, there could be weaker supply and more persistence in domestic wages and prices, including from second-round effects related to the near-term increase in headline inflation. In the other scenario, inflationary pressures could ease more quickly owing to greater or longer-lasting weakness in demand relative to supply, in part reflecting uncertainties globally and domestically.
Considering all these risks, we will continue to monitor closely the accumulation of evidence on the outlook for inflation over the medium term and set bank rate accordingly to meet the 2% target. So to conclude, our restrictive stance of monetary policy has reduced inflationary pressures in the UK economy. With the progress we've made, we've been able to take another step in making monetary policy a little less restrictive today.
A gradual and careful approach to the further withdrawal of monetary policy restraint remains appropriate. So with that, Clare, Dave, and I will be happy to take your questions.
Thank you. Great. Let's start with Ed and then please right behind you.
Thank you, Ed Conway from Sky News. Governor, could you say a little bit more about what impact you feel that tariffs are likely to have on the UK economy? And to the extent, I mean, you pointed out that we are affected by what goes on globally, to the extent that there could be a deal in the UK, how much of that 0.3% or so of impact might you hope for this to eliminate?
Well, we've set out... let me just explain a bit about how we approached this question in the round and particularly in creating the monetary policy report. And as the staff proposed to us, sort of two ways to in a sense take that into account. The first one as you say is the tariffs, the impact of tariffs themselves, and then the second one is the impact of what we've called trade policy uncertainty. And that's obviously particularly relevant because we had to face the question, we always condition our forecasts on announced policies. Obviously you have to stop the music at some point and take the policies as they are, and that's obviously quite a challenge in the current environment because obviously we expect the policies to change and of course the policies also have changed during the course of doing this round and doing this forecast. And so that's why I think bringing in the uncertainty element is very important.
So, good question. How do you think a trade agreement is going to change that? And I'll just come back to what I said a few minutes ago and take it in two parts. There's a direct effect in the UK. Now as I say I don't know what's in what we expect to be this agreement. So we'll have to wait and see how that comes through. We have the rough metrics for UK trade, UK goods trade, and of course UK goods are a smaller part of UK trade than is often the case for other countries because we have a very big trade in services in this country. But I just emphasize finally the point that I made earlier which is that the UK is a very open economy and therefore what we also had to do obviously in thinking about this forecast and we'll have to do in thinking about the next question as you say is, well what is the effect of the impact on other countries' trade as it will then pass through to the UK and as I hope what will be the effect of other trade agreements that come to pass. And we'll have to come back to that because it is important for an open economy like the UK.
Thanks, Sam Fleming from the Financial Times. Just following on the same theme, obviously in these forecasts the impact from trade to growth and inflation is extremely modest actually, a 0.3% hit to GDP in three years' time, 0.2% off inflation in a couple of years' time. Could you talk a bit about why you're so sanguine about the impact of trade? And sorry, and can we take it therefore as a corollary that you expect any upside from this trade deal, potential trade, being very modest?
I would just make one very simple point at the beginning which is that I think it's important not just to look at the trade impact but also of course to look at the way financial markets have moved in response to the news on trade and that impact. I'll hand over to Clare.
Taking my punchline, Andrew. No, you're right. The overall numbers look quite small. And that's because there's sort of three channels that are going on and have impacted the forecast here. So the first as Andrew said is the actual direct tariffs themselves and the impact that those will have on the goods traded and their effect. So you've got the tariffs at the time at which the forecasts stopped and those will feed through onto growth and onto inflation directly. You've then got the effect of the trade policy uncertainty and you can see in the charts that we've published just how high actually that's been. We've got these metrics that we can use there. You can see the size of that and of course that feeds through in multiple ways through the economy but obviously will feed through to investment particularly for those firms who are uncertain about what that means in terms of investment going forward. It will feed through into consumers as well and might be affecting some of the behavior you see there. So you've got this trade policy uncertainty component that is large and larger. And then on the other side as well, what you've got is some quite large changes in various financial markets that we've seen responding to these things. Whether that is through interest rates or exchange rates and to some extent the effects have been offsetting as you would expect and that's why in net when you look at the numbers they're not huge.
I would say this is not the case that we're not sort of focused on doing a lot of analysis of these numbers but really it's these effects and to some extent they've been offsetting in these data. I should also say of course there's a lot of uncertainty around this and this is a sort of central view. All of these factors could change, will change, or could be quite different going forward. And just, I mean, we talk a lot about uncertainty and not just at this press conference but it's been a prevailing feature. There is also, and we emphasize this, there is also now unpredictability and that has also fed into markets. So you've seen quite a lot of volatility. Obviously, we've conditioned on the assumptions that we set out as Andrew and Clare have emphasized, but at the beginning of April, for example, we saw a lot of volatility reflecting just the news flow.
We'll go Sue and then Faisal.
Hi, Sue Chan from the Telegraph. Just on that theme of uncertainty, looking at your scenarios, would more trade uncertainty as outlined in that scenario lead to faster rate cuts given the amount of slack you say will open up under that scenario?
Yeah, let me talk a bit about the scenario. But you're right in that, so what we've done here basically is think about, well look, what if the economy evolved slightly differently in a couple of key ways. And the scenario that you point to there is one of weaker demand and that could be driven by higher trade policy uncertainty. There's something else going on in that scenario which we've also said, well what would happen if that was to change the relationship between the amount of slack in the economy, the kind of pressure on resources and pricing. So you've got both of those effects going on in there. Now, what we've said is actually if you make some assumptions about how big those changes could be, you know, sort of plausible ones, what does that do? And we feed that through to inflation and to activity. And what it shows you in that world is obviously you would see lower levels of activity, lower levels of inflation and that would change the sort of monetary policy reaction there. And so you would expect policy makers to respond to that if we were to see those sorts of things playing out. Like I say, it's very much a scenario but you could motivate it by more trade policy uncertainty could be the driver and it would suggest that yes, monetary policy makers would respond to those things as you'd expect and that would mean by loosening policy. I would only caution because...
If that process led to some more substantial breaking or disrupting of supply chains, then we would have to look at the other side of the coin if you like and say to what extent, as Clare rightly says, demand is disrupted, but to what extent is the supply capacity of the world economy disrupted as well, because obviously the impact on inflation then is different. I mean that's why throughout we've said that actually on inflation it's not clear that it would necessarily be the case that what we've seen on trade policy would be deflationary. It might, and that is our central treatment that we've taken in the forecast and that's perfectly reasonable, but actually if you look at the recent experience that all economies around the world have seen over the last few years, actually it's really shown us the importance of supply chains, how complicated they are and what that can mean. So it's not necessarily the case that this should all be interpreted as an issue around demand and not necessarily around supply. And it's the balance. You'll see both and it's the balance of those two effects that matter. And modeling those supply chains is another level of difficulty as well as economists and economies throughout the world, you know, in dealing with the COVID pandemic, supply chains were a key driver there of the changes that we saw.
Faisal Islam, BBC News. Sorry, same sort of issue. Can you just go through how this filtered through to the MPC decision-making? Was the trade uncertainty, it was a tight vote in a way by four, did that affect, was that a sort of marginal impact on the vote? Did it contribute to the fact that rates were cut or cut by 0.25%?
Yeah, thanks Faisal. I mean the big point I would make is, you know, with due respect and this is not a point of criticism, don't get me wrong, I mean obviously much of the coverage in recent weeks has been on this point about tariffs and trade uncertainty. As you may have detected from the way we've sort of produced the materials and my opening remarks, we actually really have come at it the other way round and said look, we've got to go back to the fundamental situation of the UK economy to start with and what is the starting position there and a position we've inherited. And the big questions around inflation persistence, big questions around this mix of supply and demand, big questions about what's happening in the labor market and how have those moved on. And then we brought into that, if you like, best way to think about it, how has the trade policy and the tariff situation then been layered onto that and of course affected those situations. So that's the way we did it.
Thank you. I just want to switch to the vote split briefly. The three members of the panel here today were among the committee members who voted to cut rates by 25 basis points. But within that group of five, there were three who were hesitant about that and were only persuaded by, well, appears to be only persuaded by the trade moves, the tariff effects. I just wondered if you could each tell us where you sat within that group of five and what were the key domestic factors influencing those decisions?
Can I slightly rephrase the question if you don't mind? I'll put it into context because if you read... I don't always get laughs in this press conference. We'll go out feeling happy. Now, unless they're laughs of irony, I don't... The voting paragraph that you're referring to in the minutes actually uses the word 'had'. I think when I learned Latin rather badly at school, it's the pluperfect tense. But if I'm wrong, then you can... well, I don't think you can blame my Latin teacher. You can blame me. The reason, substance, is what you're in a sense playing back, Phil, is where I think we each started from if you like, sort of coming out of the last round. So some of us were in different positions as to where we sort of contemplated our next decision would be and that I think, certainly I'll speak for myself now, was based more on the question of where, going back to this point about the fundamentals of the UK situation, were. So I think the reason we phrased both paragraphs we did is I think if you were in the position of saying well I was actually more confident in the view of the disinflation part of the UK economy, then the trade news is important but it's not necessarily the thing that shifts me because I was more of the view that we were going to go there anyway. And for some of us, and look I'll answer your question by putting myself into this camp, I was very undecided frankly as to where we were going to be this time at that point in time. And then I've taken all the news into consideration and all the news by the way critically includes how the UK situation has moved on, where I do think that there are some more bits of evidence that give me confidence, particularly in this question that I spent a bit of time on in the opening remarks about where the labor market's going to and where this critical question about are pay awards going to come down to where we thought and where our agents survey thought they were going to come down to as this year goes on. And bear in mind that spring and particularly April is the critical period for pay settlements in this country. And I'm a bit more confident of that having gone over the evidence, also having gone around the country and talked to quite a few firms. I'm more confident about that and then the trade news gets layered onto that.
Well, sorry, I thought I was in the fairly undecided camp. Actually, I wasn't particularly decided one way or the other.
Thank you, Governor. Yes, your undecided nature and possibly the split kind of seems to just add to the unpredictability and uncertainty that we're all kind of facing because now we have to guess a little bit more about what you're going to do. In terms of NICs as well, I just wanted to note in your statement it says that actually you think that that's only had a very marginal impact in terms of the labor market and inflation to come. I just wondered if you might be underestimating that or how you feel, because it feels like there is that one line saying that it's a small impact and yet it keeps being referred to in the statement as actually our bank agents are telling us this, our kind of, we know that actually it's contributing to inflationary cuts and input costs rising. So just wanted to ask about that.
No, but it's interesting isn't it? So it's a fair question actually because in one sense NICs were the question if you don't mind me saying again, NICs were the story that everybody was writing the articles about a few months ago and now it's trade. Our view is look, the NICs story hasn't gone away. Actually as we set out in the materials, I don't think we've had a lot of news on the NICs story. We haven't changed our view. The development is going to pass through. And just to recap that, as you may remember we set out a menu of sort of channels through which NICs can come through. When we talk to firms, and again I've spent quite a bit of time since we last were in here talking to firms, they tend to sort of tick all boxes. And that's reasonable by the way. It's not because I think they're sort of in some sense hedging their bets. It's because actually of course you can use most of the channels in combination. I think the one thing I would say which we do point out and this is not a change but I just emphasize the point is that there is unsurprisingly the mix of the channels will change over time because some of the channels take longer to put into effect than others. So if you're improving productivity or if you're changing your workforce, you know, that and whenever your next pay settlement comes around. And so the point of that is as we say in the materials is that the effect on margins is the first one if you like to come through because that's what happens if you do nothing, then that's the one where it comes through. And I don't think we've changed our view, but I think we've reiterated that, you know, that's what firms tell us that in the first instance, they'll probably see more of it coming through there, but obviously they will then be wishing to take actions that offset that.
If I can just add on that because I think it is, although we say that the near-term impact of the rise in employer NICs on wages is expected to be relatively small on average, that to Andrew's point that is itself news because you know back in the autumn there was a lot of focus that this is going to be inflationary. But actually contacts of the bank's agents, the ones who are talking about it, saying they're going to be reducing pay rates they offer by around one to two percentage points in response to the rise. So that you know in the autumn when we were talking about this there was lots of discussion this is going to be inflationary. There still will be some element it'll be passed through that margin but what our agents are telling us is actually it's going to be pushing down on wages relative to what they would have been. And also our agents and other contacts are emphasizing that the national living wage is going to be a factor. So we have to take account of all of these factors.
Yeah. The national living wage point by the way is why I said you can't always use all channels because if you've got more of your staff are on the national living wage. Obviously the wage channel isn't open in the way that it is if they're not.
No, the national living wage actually... well my point is if one of the channels to adjusting to the NICs effect is to actually have a pay settlement that is lower than it would otherwise have been. If your staff are at the national living wage, that channel is not open to you because the national living wage determines the floor of the pay settlement.
Yeah. The well, at least the floor of the pay settlement. Yeah.
Joel Hills from ITV News. Can we talk about what are businesses telling you about US trade diverting to the UK? To what degree is that happening? To what degree are they reporting that they're seeing that affect prices domestically? And how big a factor was that in your forecast? Also, you say that you think tariffs will probably lower UK GDP by 0.3% in three years' time. What will the impact of NICs be on UK GDP, please?
