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Inflation Report November 2013 Prospects for inflation

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Chart 5.1 GDP projection based on market interest rate expectations and £375 billion asset purchases The fan chart depicts the probability of various outcomes for GDP growth. It has been conditioned on the assumption that the stock of purchased assets financed by the issuance of central bank reserves remains at £375 billion throughout the forecast period. To the left of the vertical dashed line, the distribution reflects the likelihood of revisions to the data over the past; to the right, it reflects uncertainty over the evolution of GDP growth in the future. If economic circumstances identical to today’s were to prevail on 100 occasions, the MPC’s best collective judgement is that the mature estimate of GDP growth would lie within the darkest central band on only 30 of those occasions. The fan chart is constructed so that outturns are also expected to lie within each pair of the lighter green areas on 30 occasions. In any particular quarter of the forecast period, GDP growth is therefore expected to lie somewhere within the fan on 90 out of 100 occasions. And on the remaining 10 out of 100 occasions GDP growth can fall anywhere outside the green area of the fan chart. Over the forecast period, this has been depicted by the light grey background. See the box on page 39 of the November 2007 Inflation Report or a fuller description of the fan chart and what it represents.

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Chart 5.2 CPI inflation projection based on market interest rate expectations and £375 billion asset purchases Chart 5.3 CPI inflation projection in August based on constant nominal interest rates at 0.5% and £375 billion asset purchases Charts 5.2 and 5.3 depict the probability of various outcomes for CPI inflation in the future. They have been conditioned on the assumption that the stock of purchased assets financed by the issuance of central bank reserves remains at £375 billion throughout the forecast period. If economic circumstances identical to today’s were to prevail on 100 occasions, the MPC’s best collective judgement is that inflation in any particular quarter would lie within the darkest central band on only 30 of those occasions. The fan charts are constructed so that outturns of inflation are also expected to lie within each pair of the lighter red areas on 30 occasions. In any particular quarter of the forecast period, inflation is therefore expected to lie somewhere within the fans on 90 out of 100 occasions. And on the remaining 10 out of 100 occasions inflation can fall anywhere outside the red area of the fan chart. Over the forecast period, this has been depicted by the light grey background. See the box on pages 48–49 of the May 2002 Inflation Report for a fuller description of the fan chart and what it represents.

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Chart 5.4 Probability that inflation will be above the target The November and August swathes in this chart are derived from the same distributions as Charts 5.2 and 5.3 respectively. They indicate the assessed probability of inflation being above target in each quarter of the forecast period. The 5 percentage points width of the swathes reflects the fact that there is uncertainty about the precise probability in any given quarter, but they should not be interpreted as confidence intervals.

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Table 5.A Monitoring risks to the Committee’s key judgements

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Table 5.B Calendar-year GDP growth rates of the modal, median and mean paths The table shows projections for calendar-year growth of real GDP consistent with the respective modal, median and mean projections for four-quarter growth of real GDP. The numbers in parentheses show the corresponding projections in the August 2013 Inflation Report. The November projections have been conditioned on market interest rates, and the assumption that the stock of purchased assets financed by the issuance of central bank reserves remains at £375 billion throughout the forecast period; the August 2013 projections were conditioned on constant interest rates and the same assumption about asset purchases. Where growth rates depend in part on the MPC’s backcast, revisions to quarterly growth are assumed to be independent of the revisions to previous quarters.

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Chart 5.5 Projection of the level of GDP based on market interest rate expectations and £375 billion asset purchases Chained-volume measure (reference year 2010). See the footnote to Chart 5.1 for details of the assumptions underlying the projection for GDP growth. The width of this fan over the past has been calibrated to be consistent with the four-quarter growth fan chart, under the assumption that revisions to quarterly growth are independent of the revisions to previous quarters. Over the forecast, the mean and modal paths for the level of GDP are consistent with Chart 5.1. So the skews for the level fan chart have been constructed from the skews in the four-quarter growth fan chart at the one, two and three-year horizons. This calibration also takes account of the likely path dependency of the economy, where, for example, it is judged that shocks to GDP growth in one quarter will continue to have some effect on GDP growth in successive quarters. This assumption of path dependency serves to widen the fan chart.

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Chart 5.6 Projected probabilities of GDP growth in 2015 Q4 (central 90% of the distribution) (a) (a)Chart 5.6 represents the cross-section of the GDP growth fan chart in 2015 Q4 for the market interest rate projection. It has been conditioned on the assumption that the stock of purchased assets financed by the issuance of central bank reserves remains at £375 billion throughout the forecast period. The coloured bands in Chart 5.6 have a similar interpretation to those on the fan charts. Like the fan charts, they portray the central 90% of the probability distribution. If economic circumstances identical to today’s were to prevail on 100 occasions, the MPC’s best collective judgement is that GDP growth in 2015 Q4 would lie somewhere within the range covered by the histogram on 90 occasions. GDP growth would lie outside the range covered by the histogram on 10 out of 100 occasions. The grey outline represents the corresponding cross-section of the August 2013 Inflation Report fan chart, which was conditioned on constant interest rates and the same assumption about the stock of purchased assets financed by the issuance of central bank reserves. (b)Average probability within each band; the figures on the y-axis indicate the probability of growth being within ±0.05 percentage points of any given growth rate, specified to one decimal place. As the heights of identically coloured bars on either side of the central projection are the same, the ratio of the probability contained in the bars below the central projection, to the probability in the bars above it, is given by the ratio of the width of those bars.

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See footnote to Chart 5.1. Chart 5.7 GDP projection based on constant nominal interest rates at 0.5% and £375 billion asset purchases

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The fan chart depicts the probability of various outcomes for LFS unemployment. It has been conditioned on the assumption that the stock of purchased assets financed by the issuance of central bank reserves remains at £375 billion throughout the forecast period. If economic circumstances identical to today’s were to prevail on 100 occasions, the MPC’s best collective judgement is that the mature estimate of unemployment would lie within the darkest central band on only 30 of those occasions. The fan chart is constructed so that outturns are also expected to lie within each pair of the lighter blue areas on 30 occasions. In any particular quarter of the forecast period, unemployment is therefore expected to lie somewhere within the fan on 90 out of 100 occasions. And on the remaining 10 out of 100 occasions unemployment can fall anywhere outside the blue area of the fan chart. Over the forecast period, this has been depicted by the light grey background. The calibration of this fan chart takes account of the likely path dependency of the economy, where, for example, it is judged that shocks to unemployment in one quarter will continue to have some effect on unemployment in successive quarters. The fan begins in 2013 Q3, a quarter earlier than the fan for CPI inflation. That is because Q3 is a staff projection for the unemployment rate, based in part on data for July and August. The unemployment rate was 7.7% in the three months to August, and is projected to remain at 7.7% in Q3 as a whole. In the corresponding chart in the August Report, the equivalent quarter (2013 Q2), was included in the solid line, rather than in the fan. Chart 5.8 Unemployment projection based on market interest rate expectations and £375 billion asset purchases

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See footnote to Chart 5.8. Chart 5.9 Unemployment projection based on constant nominal interest rates at 0.5% and £375 billion asset purchases

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The November swathe in this chart is derived from the same distribution as Chart 5.8 and is conditioned on market interest rate expectations; the August swathe is that shown in Chart 5.11 of the August Report and is conditioned on constant interest rates. The swathes show the probability that unemployment has reached 7% by each quarter of the forecast period. The 5 percentage points width of the swathes reflects the fact that there is uncertainty about the precise probability in any given quarter, but it should not be interpreted as a confidence interval. Chart 5.10 Cumulative probability of unemployment having reached the 7% threshold

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Table 5.C Q4 CPI inflation The table shows projections for Q4 four-quarter CPI inflation. The numbers in parentheses show the corresponding projections in the August 2013 Inflation Report. The November projections have been conditioned on market interest rates, and the assumption that the stock of purchased assets financed by the issuance of central bank reserves remains at £375 billion throughout the forecast period; the August 2013 projections were conditioned on constant interest rates and the same assumption about asset purchases.

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Chart 5.11 Projected probabilities of CPI inflation outturns in 2014 Q4 (central 90% of the distribution) (a) (a)Chart 5.11 represents the cross-section of the CPI inflation fan chart in 2014 Q4 for the market interest rate projection. It has been conditioned on the assumption that the stock of purchased assets financed by the issuance of central bank reserves remains at £375 billion throughout the forecast period. The coloured bands in Chart 5.11 have a similar interpretation to those on the fan charts. Like the fan charts, they portray the central 90% of the probability distribution. If economic circumstances identical to today’s were to prevail on 100 occasions, the MPC’s best collective judgement is that inflation in 2014 Q4 would lie somewhere within the range covered by the histogram on 90 occasions. Inflation would lie outside the range covered by the histogram on 10 out of 100 occasions. The grey outline represents the corresponding cross-section of the August 2013 Inflation Report fan chart, which was conditioned on constant interest rates and the same assumption about the stock of purchased assets. (b)Average probability within each band; the figures on the y-axis indicate the probability of inflation being within ±0.05 percentage points of any given inflation rate, specified to one decimal place. As the heights of identically coloured bars on either side of the central projection are the same, the ratio of the probability contained in the bars below the central projection, to the probability in the bars above it, is given by the ratio of the width of those bars.

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Chart 5.12 Probability that CPI inflation will be at or above the 2.5% knockout The bars in this chart are derived from the same distribution as Chart 5.2. The bars indicate the assessed probability of inflation being at or above 2.5% in each quarter of the forecast period. The dashed line shows the average of the probabilities in 2015 Q2 and 2015 Q3, consistent with the 18 to 24-month period in the MPC’s price stability knockout.

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Chart 5.13 CPI inflation projection based on constant nominal interest rates at 0.5% and £375 billion asset purchases See footnote to Chart 5.2.

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Forecast conditioning assumptions

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Table 1 Conditioning path for Bank Rate implied by forward market interest rates (a) (a)The data are fifteen working day averages of one-day forward rates to 6 November 2013. The curves are based on overnight index swap rates. (b)November figure for 2013 Q4 is an average of realised spot rates to 6 November 2013, and forward rates thereafter.

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The MPC’s forecasting record

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Chart A GDP outturns and projection in the August 2010 Report (a)Revisions, including methodological changes, account for the gap between the red and black lines prior to the vertical dashed line. (b) Based on market interest rate expectations and the assumption that the stock of purchased assets remained at £200 billion throughout the forecast period. See footnote to Chart 5.1 in the August 2010 Report for information on how to interpret the fan chart. No adjustment has been made to the fan chart to reflect the effects of methodological changes implemented in the 2011 edition of the Blue Book.

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Chart B Contributions to the news in the level of real GDP since the August 2010 Report (a) (a)Chained-volume measures. News calculated between 2010 Q1 and 2013 Q2 based on Bank staff projections made in August 2010 that were consistent with the key judgements underlying the MPC’s GDP and inflation forecasts. Those forecasts have been adjusted to be at 2010 prices. Figures in parentheses show 2009 weights in real GDP, which sum to more than 100% because imports detract from GDP. (b)August 2010 projection adjusted to reflect the effects of methodological changes implemented in the 2011 edition of the Blue Book. (c)Includes housing investment, stockbuilding, statistical adjustments and news from unexpected revisions to GDP. (d)News in the MPC’s current GDP backcast relative to the August 2010 modal GDP projection.

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(a)Based on market interest rate expectations and the assumption that the stock of purchased assets remained at £200 billion throughout the forecast period. See footnote to Chart 5.6 in the August 2010 Report for information on how to interpret the fan chart. Chart C CPI inflation outturns and projection in the August 2010 Report

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Table 1 Assessing key judgements in the August 2010 Report (a)Bank staff projections made in August 2010 that were consistent with the key judgements underlying the MPC’s GDP and inflation forecasts. (b)World trade is constructed using data for import volumes of 143 countries weighted according to their shares in UK exports. (c)For a full description of this measure see Burgess et al (2013), ‘The Bank of England’s forecasting platform: COMPASS, MAPS, EASE and the suite of models’, Bank of England Working Paper No. 471, pages 84–86. (d)Brent forward prices for delivery in 10–21 days’ time converted into sterling.

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Table 2 Contributions to the news in CPI inflation since the August 2010 Report

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Other forecasters’ expectations

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Sources: Bank of England and projections of outside forecasters provided for Inflation Reports between February 2007 and November 2013. (a)The probability implied by the MPC’s projections is based on forecasts based on market rates with the exception of August 2013, which is based on constant rates. Chart A Probabilities of inflation being above 2% two years ahead

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Table 1 Averages of other forecasters’ central projections (a) Source: Projections of outside forecasters as of 29 October 2013. (a)For 2014 Q4, there were 25 forecasts for CPI inflation, GDP growth and Bank Rate, 21 for the unemployment rate, 23 for the stock of purchased assets and 18 for the sterling ERI. For 2015 Q4, there were 23 forecasts for CPI inflation and GDP growth, 20 for the unemployment rate, 24 for Bank Rate, 22 for the stock of purchased assets and 17 for the sterling ERI. For 2016 Q4, there were 21 forecasts for CPI inflation and GDP growth, 18 for the unemployment rate, 22 for Bank Rate, 20 for the stock of purchased assets and 16 for the sterling ERI. (b)Twelve-month rate. (c)Four-quarter percentage change. (d)Original purchase value. Purchased via the creation of central bank reserves.

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Table 2 Other forecasters’ probability distributions for CPI inflation, GDP growth and the unemployment rate (a) Source: Projections of outside forecasters as of 29 October 2013. (a)For 2014 Q4, 24 forecasters provided the Bank with their assessment of the likelihood of twelve-month CPI inflation and four-quarter GDP growth falling in the ranges shown above, and 20 provided probabilities for the unemployment rate. For 2015 Q4, 22 provided probabilities for CPI and GDP growth, and 19 for the unemployment rate, and for 2016 Q4, 20 provided probabilities for CPI and GDP growth, and 17 for the unemployment rate. The table shows the average probabilities across respondents. Rows may not sum to 100 due to rounding.

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