There had been an increasing contrast between official measures of recent activity in the United Kingdom and forward-looking indicators of the outlook for the economy. The former suggested that growth had slowed little as yet, but the latter looked less robust.

The ONS Quarterly National Accounts had reported an unrevised estimate of 0.6% for GDP growth in 2007 Q4. The broad pattern of estimated demand growth had also remained unchanged, with weak growth in final domestic demand offset by stockbuilding and net trade. But it now seemed less likely that an involuntary stock cycle had been triggered. First, part of the slowdown in consumption growth in the fourth quarter had been accounted for by unusual weakness in net spending on tourism, which was known to be poorly measured; consumption of goods and services, excluding tourism spending, was estimated to have grown by 0.4%, supported by slightly aboveaverage growth in real post-tax labour income. Second, business investment was now estimated to have increased by 1.8% in the fourth quarter, whereas the previous estimate had suggested that it had fallen by 0.5%. Third, a special survey by the Bank’s regional Agents had suggested that there had not been a significant unplanned accumulation of inventories.

Indicators of output in the first quarter of 2008 pointed to stronger growth than expected at the time of the February Inflation Report. Manufacturing output had risen by 0.4% in February and industrial production as a whole by 0.3%. Although the CIPS/NTC activity measures for services and manufacturing had fallen in March, the services measure had been higher on average in the first quarter of 2008 than in the last quarter of 2007.

It remained unclear whether consumption was slowing as much as expected at the time of the February Inflation Report. The official retail sales data had been much stronger than the indications from the CBI Distributive Trades Survey, the British Retail Consortium survey and the Bank’s regional Agents. The ONS volume measure had increased by 1.0% in February; the value measure had risen by 1.2%, so price discounting did not seem to be behind the robust volume increase. The low readings from consumer confidence surveys seemed more consistent with the retail activity surveys than with the official data, although the decline in the number of respondents who thought that now was a good time to make a major purchase might be explained by the widespread commentary about the weakness in the housing market. Car sales, however, had been surprisingly strong in March.

The housing market had weakened further, with house prices falling about 1½ %(on the average of the lenders’ indices) in the first quarter. The Halifax index had fallen 2.5% in March, but this series had a record of being particularly volatile from month to month. The preview of the Royal Institution of Chartered Surveyors (RICS) survey showed that the price balance had reached its lowest level since the series began in 1978; the price expectations balance had dropped as well. The RICS preview suggested that the sales-to-stock ratio was at its lowest level since 1996. The number of mortgage approvals for house purchase and net reservations, as measured by the Home Builders Federation survey balance, had also fallen.

Future developments in the housing market and the evolution of domestic demand would be influenced by the terms and availability of credit. According to the Bank’s latest Credit Conditions Survey, there had been a widespread reduction in the availability of secured credit in the first quarter, with significant further reductions expected in the second quarter. Lenders had been withdrawing 100% mortgage offers and expecting borrowers to provide a larger fraction of equity in exchange for more favourable borrowing terms.

The implications of a weakening housing market for consumption were uncertain. Housing equity withdrawal was likely to fall back sharply. But it was unclear how far this would reduce consumer spending rather than resulting in a fall in the net acquisition of financial assets by those who would otherwise have traded down.. Tightening credit conditions were also likely to affect corporate investment. The Bank’s Credit Conditions Survey had reported a significant reduction in the availability of credit to the corporate sector in the first quarter of 2008, with further tightening expected in the second quarter.

Investmentgrade bond yields had risen, suggesting that the supply of bond finance might also have shifted downwards. But the growth of corporate borrowing had been robust in February, and average interest rates charged appeared to have fallen. That could have reflected firms drawing on pre-existing credit lines and a shift towards lending to lower-risk borrowers. Forward-looking indicators of investment had been mixed. The Bank’s Agents’ scores for investment intentions had fallen again but the latest CIPS/NTC manufacturing survey had reported a rebound in capital goods orders. 22 A preliminary analysis of the Chancellor’s Budget suggested that its implications for the outlook for growth and inflation were limited.

Supply, costs and prices

Official statistics were not yet signalling a significant downturn in labour demand. According to the ONS Labour Force Survey (LFS), employment had increased by over 150,000 in the three months to January, accompanied by a further fall in unemployment, and there had been a further rise in vacancies in February. However, total hours worked had fallen a little; also, employment had hardly changed in 2007 Q4 according to the Workforce Jobs measure. The CIPS/NTC employment surveys had picked up slightly in March, but still suggested that employment growth would be muted, as did the Recruitment and Employment Confederation (REC) survey and reports from the Bank’s Agents.

There was considerable uncertainty about the supply of workers from abroad. Some evidence pointed to a decline in net inward migration, but it remained difficult to count workers who moved back and forth between the United Kingdom and their home countries. Nominal pay growth showed no sign of rising. Settlements overall had been coming in below the level of 2007, at close to 3% in both January and February 2008 on the three-month measure. The Average Earnings Index and Average Weekly Earnings measures for the three months to January had recorded annual earnings growth, including bonuses, of 3.7% and 3.4% respectively.

The corresponding figures excluding bonuses had been 3.7% and 4.1%. The measures including bonuses had been lower than in December 2007 while those excluding bonuses had remained unchanged. The annual growth rate of the LFS measure of earnings per hour had fallen in 2007 Q4 and the more up-todate REC survey also suggested a little slackening in pay pressures for permanent staff. That might to some extent reflect respondents’ expectations of a rise in unemployment, as indicated by the drift upwards over the past few months in the balance of expectations about unemployment reported in the regular GfK survey of consumers.

Several other cost pressures, however, had intensified. Manufacturers’ input prices in February had been almost 20% higher than twelve months earlier, the highest inflation rate since the series began in 1986. Annual imported goods price inflation had reached 8%, its highest rate since 1995. The non-energy component had made a significant contribution, probably reflecting in part the lower sterling exchange rate. Input price inflation had continued to pick up in March, according to the CIPS/NTC surveys for both manufacturing and services. Annual manufacturing output price inflation, excluding duty, although no higher in February than January, had remained at its highest level since the early 1990s. The corresponding CIPS/NTC survey balance had risen further in March. However,
the Bank’s Agents had reported a sharp decline in expectations of capacity constraints over the next six months, which suggested that one source of cost pressures might abate.

CPI inflation itself had risen to 2.5% in February. In line with pre-release arrangements, an advance estimate of CPI inflation of 2.5% in March had been provided to the Governor ahead of publication. Gas and electricity prices accounted for much of the increase since the end of last year, and were set to make a further contribution over the next six months as price cuts in spring 2007 dropped out of the twelve-month comparison and announced tariff rises took effect. The short-term outlook was for a gradual rise in CPI inflation, with a high probability of temporarily reaching or exceeding 3% later in 2008. There were several near-term upside risks. First, domestic energy prices might go up more than expected at the time of the February Inflation Report, given the upward movement of the wholesale gas futures curve in the past couple of months. Second, the implied compression of retailers’ margins on non-seasonal food over the past year might unwind to some extent. Third, the additional recent depreciation of sterling would increase pressures on prices along the supply pipeline.

The upward movement in inflation had been accompanied recently by a rise in inflation expectations on both the one-year-ahead Citigroup measure and the one-year-ahead GfK measure. The Citigroup longer-time-horizon measure had also started to move up.

The immediate policy decision

At its March meeting, the Committee had judged that the downside and upside risks around its central projection for CPI inflation had risen relative to the outlook at the time of the February Inflation Report. Both had risen further, to varying degrees. Over the past month, there had been a further deterioration in the outlook for the supply of credit by banks, which would tend to constrain spending, increasing spare capacity in the economy and hence bearing down on inflation in the medium term. The pressures on banks and other market participants to reduce leverage, by reducing lending and/or raising more capital, had continued.

The Bank’s latest Credit Conditions Survey suggested that UK lenders would be tightening credit conditions for firms and households by more than had previously been expected.

The UK housing market was weakening, with prices falling, so there was an increased downside risk to residential investment and to consumption. But mortgage arrears and possessions still remained low, and employment had been rising. Some fall in the ratio of house prices to earnings was probably warranted, and could come about through varying combinations of house price adjustment and continuing growth in nominal earnings. But it was still unclear how far these housing market developments would amplify the expected slowdown in consumption growth. It would take time for tightening credit conditions to have their full impact on spending. Retail sales data for January and February suggested that consumption growth had been more resilient than the Committee had expected, but more timely survey data and reports from the Bank’s regional Agents pointed to some slowing. Some rebalancing of demand seemed to be taking place, facilitated by the depreciation of sterling. But the international outlook had deteriorated somewhat, particularly in the United States.

On the output side, UK industrial production appeared to have held up better than expected by outside commentators, and employment had been increasing. But total hours had fallen, wage growth had been muted and reports from the Bank’s Agents suggested that pressures on productive capacity were weakening.