Monetary Policy Report - February 2025

1: The economic outlook

1.1: The conditioning assumptions underlying the MPC’s projections

As set out in Table 1.B, the MPC’s February projections are conditioned on:

• The paths for policy rates in advanced economies implied by financial markets, as captured in the 15 working day averages of forward interest rates to 28 January (Chart 2.6). The market-implied path for Bank Rate underpinning the February projections declines to around 4% by the end of the forecast period, higher than in the November Report.
• A path for the sterling effective exchange rate index that is around 2¼% lower compared with the November Report. The exchange rate depreciates slightly over the forecast period, reflecting the role of expected interest rate differentials in the Committee’s conditioning assumption.
• Wholesale energy prices that follow their respective futures curves over the forecast period. Since November, gas futures have increased materially (Chart 2.4). Significant uncertainty remains around the outlook for wholesale energy prices.
• UK household energy prices that move in line with Bank staff estimates of the Ofgem price cap implied by the paths of wholesale gas and electricity prices (Section 2.5).
• Fiscal policy that evolves in line with UK government policies to date, as announced in Autumn Budget 2024.
• The growth in the size and composition of the 16+ population implied by the ONS’s 2022-based interim national population projections published on 28 January, which reflects international migration up to mid-2024.

1.2: Key judgements and risks

1.2: Key judgement 1

Progress on disinflation in domestic price and wage pressures has generally continued. In large part reflecting recent developments in global energy costs and regulated prices, headline CPI inflation is expected to rise quite sharply in the near term, to 3.7% in 2025 Q3. But the MPC judges that this pickup in headline inflation will not lead to additional second-round effects on underlying domestic inflationary pressures in the forecast.

CPI inflation peaked at around 11% at the end of 2022, following the succession of very large external cost shocks that occurred in 2021–22. Inflation fell back quite rapidly in 2023, to around 4%, and progress on disinflation has been continuing since then. This has allowed the MPC to reduce gradually the degree of monetary policy restrictiveness.

CPI inflation was 2.5% in December and also in 2024 Q4, close to expectations at the time of the November Report (Section 2.5). That was higher than in Q3 when inflation was at the MPC’s 2% target on average. The increase was primarily due to a smaller drag on annual inflation from domestic energy bills. CPI inflation excluding energy has continued to decline over the past year, albeit by less than headline inflation has since its peak, reaching around 3¼% in 2024 H2 compared with its peak of nearly 8½% in mid-2023 (Chart 1.1).

The latest evidence suggests progress on disinflation in domestic price and wage pressures has generally continued, supported by the restrictive stance of monetary policy.

Services consumer price inflation fell by more than expected in December, to 4.4%, but that in large part reflected volatility in airfares that may unwind in the new year. Higher frequency measures of underlying services inflation have been more stable but consistent with some further moderation in annual rates of inflation.

Annual private sector regular Average Weekly Earnings (AWE) growth increased to 6.0% in the three months to November, which was materially higher than the expectations in the November Report, although most other measures of pay growth have not risen over recent months (Chart 2.23). Pay growth is expected to slow significantly by the end of 2025, to around 3¾%.

That is consistent with the steer from the Agents’ annual pay survey, in which companies expected the average settlement this year to be 3.7%, towards the top of the 2%–4% range that had been suggested by Agency intelligence at the time of the November Report (Box F). This compares with 5.4% in the equivalent survey at this time last year and the 5.3% that contacts have reported for their actual 2024 settlements. More generally, this survey has tended to have a good track record of matching broad trends in aggregate pay growth. The latest evidence from the DMP Survey is also consistent with a decline in aggregate wage growth, to around 4% over the year ahead.

The November Report projection was for CPI inflation to increase further in the near term, to around 2¾% by the second half of 2025. Headline inflation is now expected to rise more sharply, to 3.7% in 2025 Q3, in large part reflecting recent developments in global energy costs and regulated prices.

The direct energy price contribution to 12-month CPI inflation is expected to increase from ‑0.6 to a positive contribution of 0.4 percentage points in 2025 Q3 (Chart 1.1). This reflects the increases since the November Report in wholesale gas futures and oil prices, and therefore household energy bills, on which the MPC’s forecast is conditioned. CPI inflation is also expected to rise in the near term due to regulated price changes and the impact of government policies announced in Autumn Budget 2024 (Chart 2.19).

The Committee judges that this near-term pickup in headline inflation will not lead to additional second-round effects on underlying domestic inflationary pressures in the forecast, and it has not changed its judgement on the speed with which overall excess domestic inflationary pressures are expected to dissipate. This in part reflects a looser labour market than at the time of the succession of very large external cost shocks. The impact of recent developments on headline inflation is also expected to be much smaller than in 2021–22. This suggests that some of the dynamics in the inflation generating process that were observed following the previous large shocks are unlikely to reoccur. Nevertheless, given the recent extended period over which inflation remained above the 2% target, the threshold for second-round effects may now be somewhat lower.

There also remain some continuing second-round effects in the forecast related to the previous very large shocks. And there remains uncertainty around how quickly such persistent inflationary pressures will dissipate in the medium term and the extent to which these risks may interact with current economic conditions (Key judgement 3). The speed at which persistent pressures fall back will depend importantly on the evolution of slack in the economy (Key judgement 2).

1.2: Key judgement 2

The recent slowdown in demand is judged to have led to only a small margin of slack opening up, as growth in the supply capacity of the economy appears to have been weakening over the past year. The margin of excess supply is expected to widen over the next couple of years, to around ¾% of potential GDP, before narrowing slightly by the end of the forecast period. The MPC continues to recognise the significant uncertainty around estimates of slack in the economy.

Global GDP growth is expected to be slightly weaker than in the November Report, primarily reflecting near-term developments in the euro area (Section 2.1). Four-quarter UK-weighted world GDP growth is projected to rise back to around 2% in 2026 and beyond.

Over recent days, the US administration has announced new tariffs on imports from some countries, and has indicated that it may impose tariffs on other trading partners as well. This news came after the MPC finalised its February Report projections, and so the forecast is not conditioned on any change in global tariffs and does not include any explicit impact from higher trade policy uncertainty. In any case, it also remains unclear what form such policies may ultimately take, and what other economies may announce in response. As discussed in Box C, while the impact on global growth is likely to be negative if such policies are implemented by the United States or by other countries in response, there is significant uncertainty around the size and the direction of any net effect on UK inflation.

UK GDP growth is estimated to have been zero in 2024 Q3, 0.2 percentage points below the projection in the November Report (Section 2.3). GDP is projected to have fallen by 0.1% in Q4 and to rise by 0.1% in 2025 Q1, also weaker than the 0.3% and 0.4% rates expected in November. The level of GDP is estimated to have been broadly flat since March 2024, and a range of recent data suggests that the labour market is continuing to loosen (Section 2.4). Business survey indicators of output growth have deteriorated over recent months, as have broader metrics of business and consumer confidence, which would be consistent with a recent slowdown in demand.

The Committee has completed its regular review of the determinants of the short to medium-term supply capacity of the economy ahead of the February forecast round. As set out in Box E, the level of potential labour supply is judged to have been materially higher over recent years following the latest revisions to the Labour Force Survey (LFS) to reflect updated population estimates. As this has not been accompanied by similar revisions to GDP, this suggests that potential productivity has been much weaker than estimated previously. Potential productivity is also now weaker than can be explained by previously identified factors such as the impacts of past shocks from Brexit and the pandemic. Some of the weakness could reflect increases in employment in health-related activities over recent years that have not been matched by a similar increase in measured output.

Based on the latest LFS data, potential productivity growth appears to have been particularly weak over the past year, and growth in the supply capacity of the economy appears to have been weakening more generally. For example, the forecast incorporates a slowdown in four-quarter potential supply growth from around 1½% at the start of 2024 to around ¾% at the start of this year. This could reflect a continuation of the structural factors that have been weighing on potential productivity, but also the possibility that additional shocks with supply-like characteristics have been affecting the economy.

The MPC continues to recognise the significant uncertainty around estimates of slack in the economy, particularly at a time when the precise factors accounting for weaker activity are not clear. That weakness could be accounted for by lower supply, or by lower demand relative to supply and hence greater slack, or more likely by a combination of both.

In the February forecast, as growth in the supply capacity of the economy appears to have been weakening over the past year, much of the current weakness in GDP growth is judged to reflect developments in supply. Given that the levels of demand and supply are still judged to have been broadly in balance throughout most of last year, this means that the recent slowdown in demand is assumed to have led to only a small margin of slack opening up. As the MPC judges that the labour market is starting the forecast period broadly in balance, this is consistent with capacity utilisation within companies being only slightly below its normal level (Chart 2.17).

The Committee has also considered carefully the impact on its projections of alternative assumptions for the degree to which recent developments in activity may reflect greater weakness in demand relative to supply. All else equal, changes in this judgement on the starting level of slack in the economy do not tend to have very large implications for the inflation forecast as long as any additional weakness in demand is assumed to unwind quickly over the forecast period. As set out below, however, there is a more material downside risk to medium-term inflationary pressures if demand were to remain enduringly weak over the forecast period.

In the February Report forecast, annual potential supply growth is projected to pick up to around 1½% in the medium term (Chart C in Box E). Within that, and reflecting the latest interim national population projections, potential labour supply growth is around ¾% per annum in the medium term. Potential productivity recovers some of its recent weakness and settles at annual growth rates of around ¾%. There could, however, be a downside risk to future potential productivity growth if there are further downward revisions to past trends in productivity, as is suggested by the latest population data that have not yet been incorporated into the LFS.

Four-quarter GDP growth is projected to pick up from the middle of this year, to over 1½% by the end of the forecast period (Chart 1.2). GDP growth in 2025 is much weaker than in the November Report, reflecting recent data developments. Quarterly growth rates are similar to in November beyond the start of this year, however. Household spending growth picks up slightly over the forecast period, supported by a declining saving ratio that in turn reflects the impact of the downward-sloping assumed path of interest rates. Business investment growth slows somewhat in the medium term.

Reflecting these paths of GDP and potential supply, the margin of excess supply is expected to widen further over the next couple of years in the February forecast, to around ¾% of potential GDP. That in part reflects the overall tightening in the stance of fiscal policy that is still assumed to occur following the Budget, and also the continuing restrictive stance of monetary policy. The margin of slack is then projected to narrow slightly by the end of the forecast period. Relative to the November Report projection, there is expected to be a somewhat greater margin of excess supply throughout the forecast period, reflecting the weaker starting point and the medium-term impact on slack from a higher market path of interest rates. The unemployment rate is projected to rise gradually to around 4¾% (Chart 1.3), above its assumed medium-term equilibrium rate of around 4½%. Unemployment is somewhat higher than in the November Report.

There are considerable risks around the future path of excess supply in the economy.

Although the MPC judges that the current stance of monetary policy is restrictive, there remain uncertainties around the impact of monetary policy on demand and hence the margin of slack in the economy (as discussed in Box C in the August 2024 Report). Box A in this Report provides a range of estimates for the evolution of the long-run equilibrium real interest rate (R*) since 2018. While cyclical developments in the economy will play a significant role in determining the restrictiveness of the monetary stance at policy-relevant horizons, R* could also play a role in that assessment as a long-term anchor for the policy rate, albeit not as a direct guide for setting policy.

As set out in Box B in the November Report, the combined effects of the measures in the Autumn Budget are expected to boost the level of GDP by around ¾% at their peak, as the stronger, and relatively front-loaded, paths for government consumption and investment more than offset the impact on growth of higher taxes. The increase in employer National Insurance contributions (NICs) was the largest change to taxation in the Autumn Budget. The Committee has reviewed the latest analysis of the impact of this change (Box D), and has not made material changes to the assumptions in the forecast on the ways in which the NICs increase is likely to be transmitted into higher prices, lower wages and employment, or otherwise absorbed into profit margins. There is a risk that a greater part of the adjustment to the increase in employer NICs comes through lower employment.

That risk sits alongside other current uncertainties in the UK and global economies that could push down on demand and hence on inflationary pressures in the medium term relative to the February forecast. These effects could be magnified if some businesses are already facing cash-flow constraints. In the other direction, if there were to be more constrained supply relative to demand, this could sustain domestic price and wage pressures.

1.2: Key judgement 3

The Committee judges that, while there have been important developments since November, the forecast remains consistent with the second case that it has identified previously regarding the evolution of the remaining persistent inflationary pressures. That is, conditioned on the market path of interest rates, the emerging margin of slack in the economy acts against some continuing second-round effects in domestic prices and wages in order for CPI inflation to fall back to around the 2% target in the medium term.

As set out in Box A in the November Report, the Committee’s recent policy deliberations have been supported by the consideration of three cases that impact the evolution of inflation persistence. The February forecast continues to be consistent with the second case, in which a period of economic slack is required in order for pay and price-setting dynamics to normalise fully. The continuing second-round effects in this forecast relate to the unwind of the succession of very large external cost shocks in 2021–22, rather than additional second-round effects from the near-term pickup in headline inflation that is now expected (Key judgement 1). Overall in this projection, the Committee has not changed its judgement on the speed with which excess domestic inflationary pressures are expected to dissipate, with no excess persistence remaining by the end of the forecast period.

In the projection conditioned on the market-implied path of interest rates in the 15 working days to 28 January, CPI inflation falls back gradually from around 3¾% in the middle of this year to around the 2% target in the medium term (Chart 1.4 and Table 1.C). This reflects the continuing restrictive stance of monetary policy and the emerging margin of slack in the economy (Key judgement 2). The February CPI projection is broadly similar to the profile in November from the middle of 2026 onwards, as downward pressure from a somewhat wider margin of slack throughout the forecast period is offset by the impact of higher near-term import price inflation owing in part to the recent depreciation of the sterling exchange rate.

Private sector regular AWE growth is expected to fall from 3¾% at the end of this year to just under 3% in the medium term, similar to the November Report from the middle of 2026 onwards (Table 1.D). Private sector unit wage cost growth is also projected to fall from 3¾% at the end of 2025 to 2¼% at the end of 2026 and to 1¾% at the end of 2027.

There remains considerable uncertainty around the calibration of the Committee’s judgement on the path of second-round effects in domestic prices and wages (as set out in Box A in the November Report). Taking recent developments together, the Committee is now placing greater weight on the second and third cases that it has been considering.

In the third case, there is a risk that the economy has been subject to lasting changes in wage and price-setting behaviour following the major supply shocks experienced over previous years. It remains possible that the path for the medium-term equilibrium rate of unemployment is higher than has been assumed in the forecast, including owing to greater costs of employment, which would be consistent with greater persistence in wage growth. The Committee is also continuing to monitor closely developments in inflation expectations, including the impact from more salient items of the CPI basket such as energy and food prices (Section 2.6).

In the first case that the Committee has considered, the unwinding of the succession of very large past global shocks would continue to feed through to weaker pay and price-setting dynamics, without the need for a period of economic slack. To the extent that this precise case relies on a continuation of weak external cost pressures and lower CPI inflation, it could be somewhat less likely than at the time of the November Report, given recent developments in global energy prices and the near-term pickup in headline inflation. Nevertheless, domestic inflationary pressures could be weaker than in the forecast for other reasons, including the possibility that more of the recent weakness in activity reflects lower demand (Key judgement 2) and that this demand weakness persists such that wages pressures are lower and companies have less pricing power going forward.

The Committee will continue to monitor the accumulation of evidence from a broad range of indicators of inflation persistence.

There also remain risks in both directions around world export price, and hence UK import price inflation. This includes the possibility of increased trade restrictions and greater trade fragmentation (Box C), although there is significant uncertainty around the size and the direction of any net effect on UK inflation.

Table 1.D: Indicative projections consistent with the MPC's forecast ^{(a) (b)}

2: Current economic conditions

Chart 2.1: In the MPC’s latest projections, GDP growth remains weak in the near term, the unemployment rate edges higher and CPI inflation rises

Near-term projections ^(a)

• Sources: ONS and Bank calculations.
• (a) The lighter diamonds show Bank staff’s projections at the time of the November Report. The darker diamonds show Bank staff’s current projections. Projections for GDP growth and the unemployment rate are quarterly and show 2024 Q4 and 2025 Q1 (November projections show 2024 Q3 to 2025 Q1). Projections for CPI inflation are monthly and show January to June 2025 (November projections show October 2024 to March 2025). The GDP growth and unemployment rate projections for 2024 Q4 are based on official data to November 2024, while the CPI inflation figures over the same quarter are outturns. Although LFS unemployment data have been re-instated by the ONS, they are badged as official statistics in development and the LFS continues to suffer from very low response rates, which can introduce volatility and potentially non-response bias (Box D of the May 2024 Report).

2.1: Global economy and financial markets

Global GDP growth is expected to slow slightly into 2025. Elevated trade policy uncertainty could depress growth further and there are downside risks from increases in tariffs.

UK-weighted world GDP is projected to have grown by 0.5% in 2024 Q4, the same rate as in 2024 Q3. Global growth is expected to slow slightly in the first half of 2025 (Chart 2.2), partly reflecting a weaker outlook in the euro area.

The US administration has introduced new tariffs on imports of traded goods from China and has indicated that it may also impose tariffs on other trading partners. China has announced some retaliatory tariffs on US goods imports and tariffs might also increase in other countries if they choose to respond to any US measures. Greater global protectionism would be likely to have a negative impact on world economic activity in the medium term, and lead to increased trade fragmentation (Box C).

Measures of global trade policy uncertainty have risen significantly since the US presidential election (Chart 2.3). Rising uncertainty may lead businesses to delay investment spending and hiring decisions until there is greater clarity over trade policy and the economic outlook (Haddow et al (2013)), which would negatively impact economic activity.

Chart 2.2: Global GDP growth is expected to slow slightly in the first half of 2025

Four-quarter UK-weighted world GDP growth with contributions by region ^(a)

• Sources: LSEG Workspace and Bank calculations.
• (a) See footnote (c) of Table 1.D for definition. Figures for 2024 Q4 to 2025 Q2 are Bank staff projections. These projections do not include the Advance Estimate of US GDP in 2024 Q4 or the preliminary flash estimate of euro-area GDP for the same quarter, as the data were published after the cut off for incorporation into the forecast.

Chart 2.3: Trade policy uncertainty has reached record highs since the US presidential election

Share of articles in selected publications discussing trade policy uncertainty ^(a)

• Sources: Caldara et al (2019) and Bank calculations.
• (a) The trade policy uncertainty index reflects automated text search results of the electronic archives of seven newspapers discussing trade policy uncertainty: Boston Globe, Chicago Tribune, Guardian, Los Angeles Times, New York Times, Wall Street Journal, and Washington Post. Data are monthly. The final data point is for December 2024.

Global export price inflation is expected to have picked up to around its pre-Covid average over the second half of last year.

Global export prices and the sterling exchange rate are key determinants of the level of UK import prices, which in turn are an important influence on UK consumer price inflation (Box D of the November 2024 Report). Global export prices, excluding oil, fell in 2023, following a period of sharp increases in 2021 and 2022. Since mid-2024, non-oil global export price inflation has stabilised, and is estimated to have averaged 1.1% on a year earlier over the second half of 2024. This was broadly in line with its pre-Covid average. Global export price inflation is expected to remain close to its pre-Covid average rate over the first half of 2025.

Wholesale gas futures prices have risen notably since November but remain significantly lower than in 2022.

Near-term natural gas futures prices have risen by around 20% since the November Report. However, gas futures prices have changed by less further out (Chart 2.4). Changes in wholesale gas prices feed into the Ofgem energy price cap for household bills (Section 2.5). Demand for natural gas has risen due to a colder-than-expected winter in Europe, leading to lower storage levels in both the UK and Europe than in previous years. Additional demand to replenish gas stores ahead of next winter is likely to maintain upwards pressure on near-term futures prices. Supply of gas has remained tight recently due to continued restrictions on Russian gas flows into Europe, along with some unplanned temporary pipeline outages. Risks to natural gas prices are judged by Bank staff to be skewed moderately to the upside in the near term, with the balance of demand and supply expected to remain tight.

Chart 2.4: Gas futures prices are notably higher than in November but remain well below their 2022 levels

Wholesale UK natural gas spot price and selected futures curves ^(a)

• Sources: Bloomberg Finance L.P. and Bank calculations.
• (a) Spot gas prices are monthly averages of Bloomberg UK NBP Natural Gas Forward Day prices. Dashed lines refer to respective futures curves using one-month forward prices based on the seven-day average to 25 October 2022, and the 15-day averages to 29 October 2024, and 28 January 2025. The final data point shown is the futures price for March 2028.

Moves in oil prices have been smaller than those in gas since November, while wholesale agricultural prices are generally little changed.

Spot Brent crude oil prices have moved slightly higher since the November Report, to US$80 per barrel. Some of this increase reflects new sanctions on Russian oil producers, which may lead to tighter supply. However, supply from non-OPEC+ producers is expected to increase this year, so prices have remained relatively suppressed. Geopolitical tensions have eased since November, particularly following the ceasefire agreement between Israel and Hamas. But direct disruption to oil supply remains an upside risk to prices.

Wholesale agricultural prices are generally little changed since the November Report, although the prices of certain commodities, such as cocoa and coffee, have risen. Changes in wholesale agricultural prices tend to feed through to consumer food price inflation with lags. Wholesale prices have been relatively stable for several months, and UK food input producer prices have fallen recently, suggesting that other factors have driven the recent increase in UK consumer food price inflation rates (Section 2.5).

GDP growth in the US is expected to remain stronger than in other major advanced economies in the near term.

According to the Advance Estimate, US GDP grew by 0.6% in 2024 Q4, following growth of 0.8% in 2024 Q3. US GDP growth is projected to slow to 0.5% in 2025 Q1, although this is likely to be stronger than growth in other major advanced economies. Risks to the US growth outlook in 2025 are two-sided and are highly dependent on the size and timing of the new US administration’s trade, fiscal and migration policies.

According to the preliminary flash release, euro-area GDP was flat in 2024 Q4. This followed growth of 0.4% in 2024 Q3, which was supported by strong consumption. The near-term outlook for euro-area activity is relatively weak. Bank staff expect euro-area GDP to expand by 0.2% in 2025 Q1. Growth in the euro area is expected to recover in the second half of 2025 as monetary policy eases, although risks are skewed to the downside due to uncertainty around global protectionist measures and the potential for renewed geopolitical tensions.

While China accounts for only a small share of UK exports, its prominent role in global manufacturing lends it an important influence in commodities and globally traded goods markets. Chinese GDP expanded by 1.6% in 2024 Q4, representing a modest acceleration from earlier quarters. Monetary and fiscal stimulus packages introduced in September and October are likely to be having some positive impact on activity, while export growth has remained strong. Since the November Report, the Chinese authorities have announced a debt-swap programme for local governments, which should provide a small boost to growth over the next few years. Chinese GDP is projected to grow by 1.1% in 2025 Q1. Further monetary and fiscal stimulus trailed by the Chinese authorities may result in some upside news to activity, but underlying domestic demand in China remains weak, and overall, risks to activity growth are skewed to the downside, particularly given recent and potential further tariff increases.

Headline consumer price inflation is projected to remain slightly above target in the US and euro area over 2025.

US PCE inflation, the Federal Reserve’s preferred measure, edged up to 2.6% in December, the highest rate in several months (Chart 2.5). PCE inflation is now expected by Bank staff to remain above target throughout 2025. Services inflation excluding energy and housing, which was 3.5% in December, continues to be the major component of headline PCE inflation.

According to the preliminary flash release, annual HICP inflation in the euro area rose to 2.5% in January, while core inflation remained at 2.7%. Bank staff expect that the pass-through of higher wholesale gas prices will also keep headline inflation in the euro area slightly above 2% this year.

Chart 2.5: Headline inflation has moved slightly above central banks’ targets in the UK, US and euro area

Contributions to annual headline consumer price inflation in the UK, US and euro area ^(a)

• Sources: Eurostat, ONS, US Bureau of Economic Analysis and Bank calculations.
• (a) Data are not seasonally adjusted. Energy includes fuel and household energy bills. Other goods is the difference between headline inflation and the other contributions identified on the chart, and therefore includes alcohol and tobacco. The latest data are November 2024 outturns for US PCE inflation and the associated contributions, and December 2024 outturns for UK CPI and euro-area HICP inflation.

Unemployment remains low in the US and euro area, while pay growth is expected to continue to ease.

Unemployment in the euro area remained close to record lows at 6.3% in December. The job vacancy rate has continued to trend lower, suggesting that excess demand for labour is easing. Annual growth in compensation per employee remained elevated at 4.4% in 2024 Q3 but is expected to moderate over 2025 as the euro-area labour market continues to loosen. The US unemployment rate also remains low, having fallen back to 4.1% in December. Employment payrolls data generally eased in 2024 but have been stronger since November. Annual pay growth continues to normalise, falling to 3.8% in 2024 Q4, although this remains above the long-run average level.

The market-implied paths for policy rates had risen since November, particularly in the UK and US, but have since fallen back.

Since the November Report, central banks in the US and euro area have continued to reduce their respective policy rates (Chart 2.6). The Federal Reserve’s Federal Open Market Committee reduced the target range for the federal funds rate by 25 basis points to 4.25%–4.5% in December, and the ECB Governing Council announced a cut to its deposit facility rate by 25 basis points to 2.75% in January. Market-implied paths for advanced economy policy rates are consistent with some further reductions this year. However, the expected pace and extent of these reductions has continued to diverge since November, with markets anticipating more loosening over 2025 in the euro area than in the UK and US.

The market-implied path for US policy rates, based on the 15 days to 28 January on which the February forecast is conditioned, had shifted up by around 55 basis points on average over the next three years, relative to the November forecast conditioning path. But US market-implied policy rates have since fallen back lower. At its December meeting, the Federal Open Market Committee suggested a slower approach to reducing policy rates in 2025 and signalled higher expectations for core and headline PCE inflation this year. Market intelligence suggests that anticipated policies by the new US administration could lead to additional inflationary pressures, although there has been growing focus on the potential impact on GDP growth of trade and immigration policies.

Market-implied policy rates in the euro area had moved by less than those in the US but were around 15 basis points higher than their November 15-day average. Expectations for stickier inflation across advanced economies have been partially offset by the relatively weaker growth outlook in the euro area. The ECB has signalled the risk of below target inflation if policy rates stay elevated for too long.

Movements in the market-implied path for the UK policy rate have been closer to those in the US curve since the November Report, having risen before falling back. On average, the forecast conditioning path for Bank Rate was expected to be around 40 basis points higher over the next three years than was the case in the November forecast conditioning path.

Based on their 15-day averages to 28 January, policy rates were expected to stand at 4.0% in the UK, 4.1% in the US, and 2.2% in the euro area in three years’ time. That was around 40 basis points, 65 basis points and 15 basis points higher than expected in the November Report for the UK, US, and euro area respectively.

Chart 2.6: The market-implied advanced economy policy rates on which the February forecast was conditioned had risen since the November Report

Policy rates and instantaneous forward curves for the UK, US and euro area ^(a)

• Sources: Bloomberg Finance L.P. and Bank calculations.
• (a) All data as of 28 January 2025. The November 2024 curves are estimated based on the 15 UK working days to 29 October 2024. The February 2025 curves are estimated using the 15 UK working days to 28 January 2025. The federal funds rate is the upper bound of the announced target range. The ECB deposit rate is based on the date from which changes in policy rates are effective. The final data points are forward rates for March 2028.

Yields on longer-term government bonds have risen across advanced economies since November.

Yields on long-term government bonds have moved higher across advanced economies since the November Report and are close to their highest levels since the 2008–09 global financial crisis in the UK and US (Chart 2.7). Rising real term premia have been the most significant driver of the moves since November.

The focus on fiscal policy in advanced economies has prompted some of the increases in long-term rates. Government borrowing is expected to be elevated across advanced economies in 2025 and coming years. Announced gilt issuance in the October Autumn Budget had been towards the upper end of market expectations, while markets are anticipating a further fiscal expansion under the new US administration. Political developments in the euro area have led to greater uncertainty around near-term fiscal consolidation.

Based on the 15-day averages to 28 January, US 10-year government bond yields were around 50 basis points higher since the November Report, while yields in the euro area had risen by around 30 basis points on average. In the UK, 10-year government bond yields had increased by around 55 basis points, although some of the move higher has since retraced. Market intelligence suggests that the repricing of gilts has been orderly, and bid-ask spreads have remained around historical averages. One model estimated by Bank staff, that decomposes movements in 10-year gilt yields, suggests that the moves since November have been primarily driven by spillovers from global shocks, with UK-specific factors playing a smaller role (Chart 2.8).

Chart 2.7: Long-term government bond yields in the UK and US are around their highs reached during the global financial crisis

Ten-year nominal government bond yields in the UK, US and Germany ^(a)

• Sources: Bloomberg Finance L.P., Tradeweb FTSE Gilt Closing Data and Bank calculations.
• (a) The final data points are yields for 28 January 2025.

Chart 2.8: Recent moves in long-term UK rates have been mainly driven by spillovers from global shocks

Decomposition of the cumulative change in 10-year UK nominal government bond yield since 31 October 2024 ^(a)

• Sources: Bloomberg Finance L.P., Tradeweb FTSE Gilt Closing Data and Bank calculations.
• (a) Methodology based on Rigobon (2003). Identification of the country-specific origins of shocks is based on asset price volatility over time. Global bars combine identified shocks from the euro area, Japan and US. Data are weekly and the latest data point is for the week to 23 January 2025.

The US dollar has appreciated significantly since the November Report, while sterling has depreciated somewhat. Equity prices have edged higher in advanced economies.

The US dollar has appreciated significantly against other major currencies since the November Report. Recent trade policy developments and broader market expectations around US tariffs have been partly responsible for this dollar strength, while widening interest rate differentials, particularly with the euro area, have also played a role. The sterling effective exchange rate has depreciated by around 2½% since November, primarily driven by weakness against the US dollar.

Advanced economy equity prices are a little higher since November. US share prices rose following the US presidential election result, as market contacts initially focused on the expected positive near-term growth impact from planned policies by the new US administration. US equity prices have been slightly more volatile recently, partly due to developments in the artificial intelligence sector and news around global trade policy. The increases in UK and euro-area equity prices have been smaller than those in the US since November. Investment-grade corporate bond spreads remain low across advanced economies, while wholesale bank funding spreads are little changed since the November Report.

2.2: Domestic credit conditions

The reductions in Bank Rate since August, and the associated falls in market interest rates, have been feeding through to most household lending products as expected.

The MPC has reduced Bank Rate since August 2024. The market-implied path for interest rates two-years ahead has fallen since its recent peak of 4.6% in May 2024, although it has risen somewhat since the November Report. The fall in reference rates since their peak has been feeding through to the rates offered on household loans and deposits (Chart 2.9).

Pass-through to household loans appears to be progressing in line with historical experience with, as expected, interest rates for some products taking longer to fall than others. Average quoted rates on two-year fixed-rate mortgages with a loan to value (LTV) ratio of 75%, for example, have fallen by 55 basis points since May 2024 (Chart 2.9). Since the November Report, average quoted rates on some fixed-term mortgages have increased slightly, reflecting the pick-up in the relevant OIS rates since September (Chart 2.9).

Rates on unsecured lending products tend to respond to changes in reference rates more slowly. Quoted rates on representative credit cards, for which Bank Rate is the main reference rate, have risen around 7 basis points since May 2024. Quoted rates on personal loans have also edged up since May 2024.

Chart 2.9: The declines in Bank Rate since August 2024, and the associated falls in the market-implied path of future Bank Rate, have been feeding through to most household deposit and lending rates

Average interest rates on selected household products and their respective reference rates ^(a)

• Sources: Bank of England, Bloomberg Finance L.P. and Bank calculations.
• (a) The Bank’s quoted rates series are weighted monthly average rates advertised by all UK banks and building societies with products meeting the specific criteria. Series are not seasonally adjusted. January 2025 data, shown in diamonds, represent the average of daily quoted rates using data to 28 January and were provisional. The 75% and 90% LTV mortgage rates and savings bond rates are for two-year fixed-rate products. Series shown in white on each panel represent the respective reference rates for the products shown. OIS rate shows monthly averages, while Bank Rate shows month-end numbers. The OIS diamond shows the average of daily rates to 28 January.

Past increases in mortgage rates are expected to result in higher interest rates for some mortgagors rolling off existing fixed-rate mortgages.

Most UK mortgages are held on a fixed-rate basis, with around two thirds of the stock of mortgages currently at a five-year fixed-rate period from origination. Around a third of those on fixed-rate mortgages have not re-fixed since rates started to rise in mid-2021, so the full impact of higher interest rates since then has not yet been passed through to all mortgagors. Bank staff estimates, informed by the FCA Product Sales Data, suggest that just under half of mortgages are likely to see payment increases between December 2024 and 2028 Q1.

Interest rates for those on variable rate mortgages have fallen back from their peaks. A growing number of those who are already paying higher rates may be able to refinance at a lower rate over the next two years. Just over a quarter of mortgage accounts are expected to see monthly payments decrease between December 2024 and 2028 Q1.

Pass-through of Bank Rate changes to household instant-access deposit rates has continued to be lower and slower than historically.

Quoted instant-access deposit rates, for which Bank Rate is the main reference rate, have fallen by 15 basis points on average since May 2024 (Chart 2.9). Pass-through from recent cuts in Bank Rate has been partial and slow when compared to previous cuts when Bank Rate had been at a similar level. That may be partially a consequence of relatively low pass-through during the most recent Bank Rate tightening cycle.

Interest rates on term deposit products, such as those for two-year fixed-rate bonds, have been evolving as expected following movements in the two-year OIS rate (Chart 2.9).

Money growth has been normalising since its post-pandemic weakness.

Aggregate broad money growth has been normalising since its post-pandemic weakness. Broad money holdings increased markedly during the pandemic, reflecting a combination of resilient bank lending growth and the effects of quantitative easing (Box B in the May 2024 Report). This was followed by a period of notably weak money growth over 2022 and 2023 and an erosion of the money overhang that had emerged during the pandemic. The ratio of aggregate money to GDP has returned to close to its pre-pandemic trend (left panel of Chart 2.10).

Within the sectoral breakdown, flows into household broad money were notably strong in October 2024 at around £20 billion (right panel of Chart 2.10). Market intelligence suggests those flows were the result of a pick-up in the sale of investments by some households in October. The strength appears to have been temporary, however, with household money flows close to their 2012–19 average in December.

Chart 2.10: Household deposit flows were particularly strong in October 2024, but have since normalised

Ratio of aggregate broad money to nominal GDP and sectoral broad money flows ^{(a) (b)}

• Sources: Bank of England, ONS and Bank calculations.
• (a) Data for the left panel are quarterly. Aggregate broad money captures M4 excluding the deposits of intermediate other financial corporations and is break-adjusted. The dashed line in the left panel shows the 2012–19 trend in the ratio of aggregate broad money to nominal GDP, projected forward. The final data points shown on left panel are for 2024 Q3. The diamond represents a provisional estimate for 2024 Q4, using the latest Bank staff projection for nominal GDP.
• (b) Data for the right panel are monthly. Aggregate broad money captures M4 excluding the deposits of intermediate other financial corporations. PNFCs shows broad money flows for private non-financial corporations and NIOFCs shows broad money flows for non-intermediate other financial corporations. For more detail on what is captured within each sector, see Further details about sectoral analysis of M4 and M4 lending data. As the sectoral components are seasonally adjusted separately, they may not sum to the total. Latest data shown on right panel are for December 2024.

Consumer credit growth has moderated slightly and is now in line with its pre-pandemic average.

Annual consumer credit growth had been strong since mid-2022. That in part reflected some recovery from the weakness observed during the pandemic. This strength was driven by growth in credit card lending, with some households possibly borrowing to smooth their consumption in response to recent high inflation (StepChange (2024)). Consumer credit growth has moderated somewhat in recent months, to 6.5% in December, and is now broadly in line with its 2012–19 average.

There are signs that housing market activity is picking up.

Monthly mortgage approvals for house purchase have risen notably since the start of 2023 and are now slightly above their 2012–2019 average. The recovery, in part, reflects declines in the average rate paid on new mortgages since quoted rates peaked in mid-2023. Banks responding to the 2024 Q4 Credit Conditions Survey also reported increased availability of secured lending to households, which was expected to continue into 2025 Q1.

In line with the recovery in housing market activity, nominal house prices have continued to pick up. The official ONS UK HPI measure rose by 3.0% in the three months to November compared with the same period a year ago. The recovery in house prices partly reflects past interest rate rises providing less of a drag.

Corporate lending volumes have been increasing, with some cautious signs of recovery in lending to SMEs.

Corporate lending volumes were weak following the pandemic, particularly for SMEs, reflecting the fact that many businesses had borrowed through the various pandemic-era government loan schemes. Corporate lending growth has since recovered somewhat, reaching 1.9% in the 12 months to December, notwithstanding the downturn in indicators of broader business sentiment (Section 2.3). In addition, there are some cautious signs of that recovery in lending extending to SMEs, with a positive monthly flow of lending to SMEs since October. Banks responding to the 2024 Q4 Credit Conditions Survey reported an increase in both availability and demand for corporate lending from smaller businesses and a slight increase from medium and large firms.

2.3: Domestic activity

GDP growth slowed in the second half of 2024.

Having grown solidly in the first half of the year, GDP growth was flat in 2024 Q3, 0.2 percentage points below the projection in the November Report. Household consumption grew by around ½% on the quarter, as did government spending, and business investment grew strongly at nearly 2%. Growth in these expenditure components was offset by a decline in housing investment and a negative contribution from net trade excluding precious metals.

Weak growth continued into the final quarter of last year. On a monthly basis, GDP is estimated to have been flat in the three months to November, which leaves the level of GDP broadly unchanged since March. Weakness has been more pronounced in the market sector, in which output has recorded little growth over the past year while activity in predominantly public sectors has been rising strongly. Bank staff now expect GDP to have fallen by 0.1% in 2024 Q4, lower than the 0.3% quarterly growth projected at the time of the November Report.

Chart 2.11: GDP has been flat since early 2024

Change in measures of activity since 2022 Q4 ^(a)

• Sources: ONS and Bank calculations.
• (a) Public sector output includes public administration and defence, education, and human health and social work activities. Market sector output equals total GDP excluding public sector output.

Although GDP growth has been more volatile than suggested by business surveys, underlying growth appears to have slowed since the middle of last year.

Business surveys have suggested a smoother path for GDP growth in recent quarters. GDP growth was above the steer from surveys of businesses’ activity in the first half of last year but then slowed to a rate below what these surveys implied in Q3. The S&P Global UK composite output PMI has fallen sharply since last summer and remained below its historic average at 50.6 in the January release. Both the services and manufacturing output balances have fallen since last summer, with respondents primarily linking this to domestic factors, although global factors were also often cited.

The collective steer from surveys now points to a further slowdown in underlying growth at the end of 2024 and into the start of this year (Chart 2.12). GDP growth is projected to pick up to 0.1% in 2025 Q1, 0.3 percentage points weaker than expected at the time of the November Report. Contacts of the Bank’s Agents also report that activity has remained subdued around the turn of the year, although they expect some pickup in 2025 as whole. As a result, underlying growth is currently weaker than expected at the time of the November Report.

Chart 2.12: GDP growth has slowed over the course of 2024

Three-month on three-month growth in GDP and quarterly GDP growth implied by business surveys ^(a)

• Sources: British Chambers of Commerce (BCC), CBI, Lloyds Business Barometer, ONS, S&P Global and Bank calculations.
• (a) The final data points are for the three months to November 2024. The diamonds to Q3 show in-sample fitted values of the survey indicator model and diamonds for 2024 Q4 and 2025 Q1 show out of sample projections.

Business confidence has also deteriorated in recent months.

The weakening in economic activity has been associated with a deterioration in business confidence, as evidenced across a range of measures (right panel, Chart 2.13). The British Chambers of Commerce and ICAEW measures of business confidence both declined sharply in 2024 Q4. Similarly, the Lloyds Business Barometer overall business confidence measure ticked down for the fifth month in a row in January. The ONS BICS net balance of firms’ performance expectations over the coming 12 months declined for the fifth consecutive month in December, to its lowest level since the end of 2022. Across the range of surveys, various factors have been cited as reasons for the deterioration in business confidence. These include geopolitical and trade uncertainty, but also the impact of recent changes to taxation. Surveys of business confidence are often more volatile than businesses’ reported output. However, if this weak sentiment persists, it presents some downside risks to the projection for GDP growth.

Chart 2.13: Survey measures of consumer confidence remain subdued and business confidence has declined in recent months

Consumer and business confidence indicators ^(a)

• Sources: BCC, Deloitte CFO survey, GfK, Lloyds Business Barometer, S&P Global/CIPS and Bank calculations.
• (a) The swathe in the right panel is comprised of the BCC confidence in turnover over the next 12 months, PMI future output indicator, Deloitte net balance for optimism about financial prospects and Lloyds net balance for firms’ trading prospects over coming year. Values in both panels shown as standard deviations from their mean values since 2000 Q1.

Firms’ investment intentions have also softened. Investment intentions indicators from the PMI and DMP Surveys have fallen over 2024 Q4, and intelligence from the Bank’s Agents points to rising uncertainty, squeezed cash flow and higher borrowing costs deterring capital investments. Business investment growth has been strong recently, expanding by 1.9% in 2024 Q3 and having grown by nearly 1% per quarter on average over the past two years. The weakening in business sentiment suggests slowing business investment growth. Bank staff expect quarterly growth of 0.4% and 0.6% in 2024 Q4 and 2025 Q1, respectively.

Indicators of household spending have also weakened in recent months but consumption growth is expected to pick up again in 2025.

Having grown steadily in the first three quarters of 2024, more recent indicators of household spending have weakened. Retail sales fell by 0.8% in 2024 Q4. Alongside that, consumer confidence has been weak around the turn of the year. The headline GfK measure fell sharply in January (left panel, Chart 2.13), to its lowest level since December 2023, while the S&P UK Consumer Sentiment Index also fell notably. Savings intentions, according to the GfK survey, remain very elevated. However, surveys of consumer confidence are not always reliable predictors of household consumption.

Household consumption growth is expected to be flat in 2024 Q4 before picking up slightly to 0.2% in 2025 Q1. That is weaker than expected at the time of the November Report and broadly consistent with intelligence from the Bank’s Agents network where consumer-facing firms also report subdued levels of demand. Beyond that, consumption growth is expected to pick up further over this year, supported by a declining saving ratio and a reduced drag from past interest rate rises.

2.4: The labour market and slack

Employment growth appears to have softened in recent months and there are downside risks in the near term.

Staff judge that underlying employment growth has been stable at around 0.2% over much of 2024 (Chart 2.14), although recent data point to a slowing in the pace of growth towards the end of the year. The latest LFS data suggest that employment grew by 0.1% in the three months to November, down from quarterly growth of around 1% in the summer of 2024. Alternative indicators suggest a weaker picture. HMRC RTI payrolls employee data declined for a second consecutive month in December, implying a fall in payroll employment of 0.1% in 2024 Q4 (Chart 2.14). However, early vintages of the payrolls data are subject to frequent and sizeable revisions. More broadly, during 2024 payrolled employment has been supported by strong growth in the public sector while private sector payrolls have been declining.

Chart 2.14: Employment growth appears to have softened though the steer from employment indicators is mixed

Measures of employment growth ^(a)

• Sources: Bank of England Agents, HM Revenue and Customs, KPMG/REC/S&P Global UK Report on Jobs, Lloyds Business Barometer, S&P Global, ONS and Bank calculations.
• (a) Bank staff’s indicator-based models of near-term employment growth use mixed-data sampling (MIDAS) techniques (Daniell and Moreira (2023)). Latest data are three months to November for LFS employment and December for HMRC RTI employment. Quarterly estimates of underlying employment growth extend to 2024 Q4.

Bank staff judge that LFS employment growth was 0.2% in the final quarter of 2024 and will fall slightly to 0.1% in 2025 Q1. However, there are downside risks to the outlook for employment in the near term. Some survey-based employment indicators have weakened notably since the November Report. The composite PMI employment balance fell sharply in December and was little changed on the month in the January reading, at around its lowest level since January 2021. Other survey measures of employment, such as those from the REC and DMP surveys have also weakened, with the increase in employer National Insurance contributions being cited as a key reason by firms (Box D).

The unemployment rate is judged to have risen only slightly over 2024.

The latest LFS data suggest that the unemployment rate ticked up to 4.4% in the three months to November, having been between 4.1%–4.4% since the start of 2024. Staff estimates of the underlying unemployment rate, which utilise additional data such as the claimant count and measures of recruitment difficulties, also point to a broadly stable rate of unemployment in recent quarters (Chart 2.15). Looking ahead, measures of redundancy intentions point to little change in the path for unemployment, though this differs somewhat to the weaker steer from surveys of employment. Bank staff expect the rate of unemployment to be around 4.4% in 2024 Q4, rising to 4.5% in 2025 Q1 where it remains over the remainder of 2025.

Chart 2.15: The underlying unemployment rate has been stable in recent quarters

Quarterly change in the unemployment rate ^(a)

• Sources: Bank of England Agents, Google Trends, S&P Global, KPMG/REC UK Report on Jobs, ONS and Bank calculations.
• (a) Bank staff’s indicator-based models of near-term unemployment use mixed-data sampling (MIDAS) techniques (Daniell and Moreira (2023)). Latest data are to 2024 Q3 and the diamonds show the model implied values for 2024 Q4 and 2025 Q1.

The official labour market data have undergone significant revisions but low response rates remain an issue.

In December the ONS revised the LFS data to reflect updated population estimates, which are used to weight the responses to the survey. The ONS has incorporated upward revisions to the estimated population of around half a million people. These revisions have raised the rate of participation and employment implied over the recent past, although the unemployment rate is broadly unchanged (Box E).

While the recent LFS reweighting helps to begin to reconcile different measures of employment, it does not address the continuing issues caused by low response rates (see Box D, May 2024 Report). The ONS continues to recommend caution when interpreting the latest LFS data. The MPC continues to employ a wide range of data to inform its understanding of the labour market and the uncertainties surrounding LFS data underscore the importance of this approach.

Demand for workers has continued to ease and the labour market is now judged to be broadly in balance.

Vacancies have continued to decline at a similar pace to recent quarters, falling by around 24,000 in the three months to December. This leaves the ratio of vacancies to unemployment – a measure of labour market tightness – close to pre-pandemic levels.

Analysis by Bank staff supports the MPC’s judgement that the labour market has returned to a broadly balanced position. This analysis examines the difference between the observed ratio of vacancies to unemployment and an estimate of its equilibrium. This equilibrium takes account of factors including the lower cost of posting vacancies over time and is informative as observed labour market tightness has exhibited an upward trend over time. The estimate for the equilibrium V/U ratio (aqua line in Chart 2.16) has moved higher from 2014 onwards before flattening off around the time of the pandemic. The observed V/U ratio (orange line in Chart 2.16) moved upwards towards its estimated equilibrium before the pandemic. Since the pandemic, the labour market has been exceptionally tight, before starting to gradually rebalance over the last two years. The latest data show the V/U ratio is back to around its estimated equilibrium. This assessment is consistent with the steer from other indicators of labour market slack, such as the Agents’ measure of recruitment difficulties and those in the REC survey.

Chart 2.16: Tightness in the labour market has continued to ease and the market is judged to be broadly in balance

Vacancies to unemployment ratio and estimated equilibrium values ^(a)

• Sources: AA/WARC Expenditure Report, ONS and Bank calculations.
• (a) The equilibrium V/U ratio is estimated using an error-correction model over the period 1982–2023. The real cost of vacancy posting and hourly labour productivity are included as long-run determinants for the level of vacancies. The model also includes controls for short-term movements in these variables. Further technical details will be available in a Bank Underground post (Stelmach et al (forthcoming)). The final data points for both series in the chart are 2024 Q3.

A small margin of economic slack is now judged to have opened up at the end of 2024, though demand and supply remain close to balance.

While GDP growth has weakened noticeably, this has not been reflected to the same extent in estimates of spare capacity across the economy. Alongside the analysis above that suggests there is little excess tightness in the labour market, survey measures of capacity utilisation also point to only a small degree of spare capacity within firms (left panel, Chart 2.17). Meanwhile, top-down estimates of the output gap based on statistical techniques point to it having widened a little over the course of 2024 (right panel, Chart 2.17). Each of these approaches to judging spare capacity are considerably uncertain.

In light of the relative stability in measures of spare capacity compared to those of activity, the current weakness in GDP is judged to reflect not only a slowdown in demand but also a degree of weakening in supply growth over the past year (Section 1 and Box E). There is now estimated to be a small margin of economic slack around the turn of the year compared to the broadly balanced position expected at the time of the November Report (Section 1), but not as large as implied by the weakening in activity on its own. The MPC expects that the margin of slack will open up further, and to a slightly greater extent than in the November Report (Section 1), before narrowing slightly by the end of the forecast period.

Chart 2.17: Measures of capacity utilisation are close to historical averages and output gap models signal a modest widening of economic slack

Survey indicators of capacity utilisation and model-based estimates of output gap ^{(a) (b)}

• Sources: Bank of England Agents, BCC, CBI, ONS, S&P Global/CIPS and Bank calculations.
• (a) Standard deviations from averages between 2000–19. The measures included in the swathe are from the Bank’s Agents, the BCC (non-services and services), the CBI (manufacturing (capacity); financial services, business/consumer/professional services and distributive trade (business relative to normal)) and CIPS (manufacturing (backlogs); services (outstanding business)). Sectors are weighted using shares in gross value added. The BCC data are not seasonally adjusted. The data are shown to 2024 Q4.
• (b) The model-based estimates of the output gap are based on a variety of multivariate filters whose mean values are standardised to the MPC’s estimate of the output gap. The final data point in the chart is 2024 Q4.

2.5: Inflation and wages

Headline CPI inflation rose to 2.5% in December, above the MPC’s 2% target.

Twelve-month CPI inflation was 2.5% in December, up from 1.7% in September (Chart 2.18). The rise in headline CPI inflation over 2024 Q4 was primarily due to a smaller drag on annual inflation from domestic energy bills. Core CPI inflation, which excludes energy, food, beverages and tobacco, fell in December, to 3.2%, a little below the expectation in the November Report but still historically elevated.

The increase in headline CPI inflation over Q4 was broadly in line with the expectation at the time of the November Report. However, within that, stronger-than-expected food and core goods price inflation was offset by weaker-than-expected services inflation, particularly in airfares.

Chart 2.18: CPI inflation was 2.5% in December, and is expected to rise over the first half of 2025

Contributions to CPI inflation ^(a)

• Sources: Bloomberg Finance L.P., Department for Energy Security and Net Zero, ONS and Bank calculations.
• (a) Figures in parentheses are CPI basket weights in 2024. Data are shown to December 2024. Component-level Bank staff projections are shown from January to June 2025. The food component is defined as food and non-alcoholic beverages. Fuels and lubricants estimates use Department for Energy Security and Net Zero petrol price data for January 2025 and are then projected based on the sterling oil futures curve.

CPI inflation is projected to rise further in the near term, reaching 3.7% in 2025 Q3, mainly driven by higher energy prices.

Headline CPI inflation is expected to continue to rise in the near term, reaching 3.5% by June (Chart 2.18). Consistent with the expected rise in near-term inflation, the latest S&P Global UK composite input and output price indices have both picked up since October 2024.

The single largest driver of the further pickup in inflation is household energy bills and fuel prices (Chart 2.19). The Ofgem energy price cap for the typical household has risen from £1,568 in July 2024 to £1,738 in January 2025 and is expected to rise somewhat further in April. As previous large falls in domestic energy bills have also fallen out of the annual inflation calculation, household energy is expected to contribute around ½ of a percentage point to the rise in headline inflation between December 2024 and June 2025. This is a larger rise than expected at the time of the November Report, due to the observed increases in wholesale energy costs (Section 2.1), which underpin the Ofgem energy price cap.

Regulated price changes and the impact of government policies announced in Autumn Budget 2024 are also expected to contribute to the near-term increase in inflation. Collectively these are projected to add around ½ of a percentage point to headline inflation by 2025 Q2 (Chart 2.19). This is made up of a rise in the cap on bus fares and the introduction of VAT on private school fees, which push up on services inflation from January, along with an increase in water bills taking effect from April. The increase in employer NICs is also assumed to have a small upward impact on inflation as firms pass on higher costs to their prices.

Bank staff judge that the recent weaker-than-expected airfares outturn is likely to unwind, which is also expected to push up on services inflation from January, though services inflation is expected to slow again in June (azure bars in Chart 2.19). In addition, as set out below, non-energy goods price inflation is expected to be slightly higher than projected in the November Report.

CPI inflation is expected to rise a little further to 3.7% in 2025 Q3, mainly on account of further pass through of recent developments in global energy costs, before beginning to ease again from the final quarter of the year (Section 1).

Chart 2.19: CPI inflation is expected to rise materially over 2025 H1, with changes in energy prices the main driver

Projected contributions to cumulative change in CPI inflation from December 2024 ^(a)

• Sources: Bloomberg Finance L.P., Department for Energy Security and Net Zero, ONS and Bank calculations.
• (a) Data to December 2024. Component-level Bank staff projections from January to June 2025. The energy component includes fuels and lubricants and electricity and gas. The NICs bars show Bank staff estimates of the pass-through of the increases in employer NICs announced in Autumn Budget 2024 to headline CPI inflation. The other regulated/indexed component includes education, other transport services, other services for personal transport equipment and communication services. The water bills component includes water supply and sewerage collection. The food component is defined as food and non-alcoholic beverages excluding the estimated impact of the changes to employer NICs. The other goods component is defined as goods excluding energy, food and non-alcoholic beverages, water supply and the estimated impact of the changes to employer NICs on goods inflation. The other services component is defined as services excluding education, other transport services, other services for personal transport equipment, communication services, sewerage collection and the estimated impact of the changes to employer NICs on services inflation.

Core goods and food price inflation rose in 2024 Q4 and are expected to rise further above their pre-Covid averages in the near term.

Core goods and food CPI inflation fell materially over 2023 and early 2024 (Chart 2.20), following declines in the prices of key inputs such as energy and other externally driven cost pressures.

Both core goods and food price inflation measures have begun to pick up more recently. Annual core goods inflation was 1.2% in December, above its pre-Covid average rate and 0.5 percentage points higher than expected in the November Report (Chart 2.20). Alongside that, the rate of annual food and non-alcoholic beverage inflation was 2.0% in December, around 1 percentage point higher than expected in the November Report projection.

Recent increases in core goods and food price inflation are likely in part to reflect rising labour cost pressures. Intelligence from the Bank’s Agents suggests labour costs are playing an increasing role in these sectors, given recent NLW increases and the upcoming increase in employer NICs.

Core goods and food price inflation are expected to rise somewhat further above their pre-Covid averages in the near term (Chart 2.20). For core goods inflation, that in part reflects previous weakness in price rises falling out of the annual inflation calculation. Both components are affected by the impact of tax and regulatory changes in the first half of the year. The food and drinks sector is also expected to be affected by the Extended Producer Responsibility (EPR) regulations, which come into effect from October 2025. These regulations increase the responsibility of some organisations in the supply chain for paying the recycling costs of packaging materials. Some contacts of the Bank’s Agents in the sector expect the impact of the EPR for their business could be similar to that of the increases in employer NICs.

Chart 2.20: Core goods and food price inflation are slightly above their pre-Covid averages while services inflation remains elevated

Annual inflation rates for components of CPI ^(a)

• Sources: ONS and Bank calculations.
• (a) The core goods component is defined as goods excluding food and non-alcoholic beverages, alcohol, tobacco and energy. The food component is defined as food and non-alcoholic beverages (FNAB). Data are to December 2024. Bank staff projections from January to June 2025. Dashed lines represent the 2010–19 averages, which are 3.0%, 1.6% and 0.8% for services, FNAB and core goods respectively.

Underlying inflationary pressure in services is continuing to moderate. Services inflation is expected to rise again in the near term, however, driven mainly by one-off or volatile factors.

Annual services price inflation has continued to moderate from its peak but remains elevated relative to the rate previously seen as compatible with the achievement of the inflation target (Chart 2.20). Annual services price inflation fell to 4.4% in December, down from 5.0% in November. The December outturn was 0.4 percentage points lower than projected in the November Report, mainly driven by the smaller-than-expected increase in airfares.

Services inflation is expected to rise to just above 5% in January and average around that rate over 2025 H1 (Chart 2.20). That rise is driven in part by volatile factors, including the expected reversal of the weaker-than-expected increase in airfares in December. In addition, the range of regulatory and fiscal measures outlined above – including increases in private school fees, bus fares, Vehicle Excise Duty, sewerage bills and employer NICs – are expected to be adding just under 1 percentage point to headline services inflation in April 2025. Headline services inflation is then expected to fall back a little, to 4.7% in June.

Bank staff judge that, looking through the impacts of regulatory and fiscal measures and other one-off factors, underlying services inflationary pressures will continue to ease slightly over 2025 H1. Measures of underlying services price inflation have been gradually easing, broadly as expected at the time of the November Report, though they remain elevated (Chart 2.21). Consistent with this, there has been an easing in underlying pay pressures since mid-2023, with these expected to abate further over 2025 (Chart 2.22). Intelligence from the Bank’s Agents also points to a modest slowing in the pace of services price inflation in the coming year.

Chart 2.21: Underlying services inflation measures have continued to moderate

Measures of annual services price inflation ^(a)

• Sources: ONS and Bank calculations.
• (a) The low variance measure is calculated by weighting each component of services inflation by the inverse variance of the change in 12-month inflation of that component from 12 months previously. The maximum adjusted weight is capped at twice its original value. Details on the components which have been included/excluded from the ‘Services excluding indexed and volatile components, rents and foreign holidays’ measure are included in the accompanying spreadsheet published online. There has been a small definitional change to this series compared with versions shown in previous Reports to remove the passenger transport by bus and coach component. The trimmed mean measure excludes the 10% largest and 10% smallest price changes. The latest data points shown refer to December 2024.

Private sector regular pay growth was stronger than expected towards the end of 2024…

Wage growth remains an important factor behind the remaining persistence in services inflation. Annual growth in private sector regular average weekly earnings (AWE) rose by 6.0% in the three months to November (Chart 2.22), notably higher than anticipated in the November Report. Bank staff’s indicator model of underlying pay growth – based on a statistical combination of signals from a range of pay indicators – points to underlying wage growth being little changed on the quarter at 5.2% in 2024 Q4, however.

Chart 2.22: Official AWE growth has picked up in recent months, but is expected to moderate over the coming year

Measures of annual private sector wage growth ^{(a) (b)}

• Sources: Bank of England Agents, DMP Survey, HMRC, Indeed, KPMG/REC UK Report on Jobs, Lloyds Business Barometer, ONS and Bank calculations.
• (a) Private sector regular pay growth in the aqua line shows the ONS measure of private sector regular average weekly earnings growth (three-month average on same three-month average a year ago). Bank staff’s indicator-based model of near-term private sector regular pay growth is quarterly and uses mixed-data sampling (or MIDAS) techniques. A range of indicators inform the model, including series from the Bank of England Agents, the Lloyds Business Barometer, Indeed, ONS/HMRC PAYE payrolls and the KPMG/REC UK Report on Jobs. Indicators are weighted together according to their relative forecast performance in the recent past. Latest data points are for the three months to November 2024 for private sector regular pay and 2024 Q4 for the indicator-based model estimates.
• (b) Diamonds indicate projections or expectations for pay growth. Definitions of wage growth vary between each of the measures. The Agents’ pay survey diamond shows respondents’ expected average pay settlements in 2025, weighted by employment and sector. The DMP diamond shows average expected pay growth one year ahead for respondents to the January 2025 DMP Survey. Pay growth projections are for 2024 Q4 to 2025 Q4.

Within that, some individual indicators are stronger at present. Annual growth in median private sector pay derived from HMRC payrolls data (aqua line Chart 2.23), for example, pointed to pay growth of around 6.4% in the year to December and has shown limited signs of moderation in recent months.

Chart 2.23: Some indicators offer a firmer read for pay growth than others at present

Measures of annual private sector wage growth ^(a)

• Sources: DMP Survey, HMRC, Indeed, KPMG/REC UK Report on Jobs, ONS and Bank calculations.
• (a) Definitions of wage growth vary between each of the measures. Private sector regular pay growth is the ONS measure of private sector regular average weekly earnings growth (three-month average on same three-month average a year ago). DMP shows three-month average realised pay growth from the DMP Survey. KPMG/REC shows average starting salaries for permanent staff compared to the previous month. The KPMG/REC index is mean-variance adjusted to ONS private sector regular pay growth over 2002–19 and is advanced by 12 months, which better reflects the leading relationship between the KPMG/REC index and the ONS measure of pay growth. HMRC Real-Time Information (RTI) shows median of private sector employee pay growth. Indeed shows annual average job title matched pay growth for UK job vacancies. Latest data points are the three months to November 2024 for private sector regular pay, December 2024 for Indeed, HMRC RTI and the KPMG/REC index, and January 2025 for the DMP Survey.

…and while it is expected to moderate over 2025, it will remain elevated by historical standards.

Annual private sector wage growth in the MPC’s baseline projection is expected to slow to around 3¾% by the end of 2025, as the easing in the labour market and past falls in inflation expectations feed through to lower wage growth (Chart 2.22). That is ½ of a percentage point higher than the November 2024 Report projection.

The higher expected path for pay growth in part reflects the steer from the latest Agent’s annual pay survey. This points to some moderation in pay settlements in 2025 relative to 2024, to 3.7% (Chart 2.22 and Box F). This estimate is at the higher end of the range of 2%–4% indicated by the Agents’ intelligence at the time of the November Report. Estimates from the Agents’ pay survey have historically been a good predictor of realised pay settlements (Chart 2.24).

Chart 2.24: Estimates from the Agents’ pay survey have historically been a good predictor of pay settlements

Measures of annual pay settlements ^(a)

• Sources: Bank of England Agents, Incomes Data Research, Incomes Data Services, Industrial Relations Services, Labour Research Department and Bank calculations.
• (a) The Agents’ pay survey diamonds shows respondents’ expected average pay settlements for a given year (as reported on the survey the year prior). Estimates are weighted by employment and sector. Latest diamond in purple shows respondents’ expected average pay settlements for 2025. The Bank of England private sector settlements database is informed by intelligence gathered from the Bank’s Agents, Incomes Data Research, Incomes Data Services, Industrial Relations Services, and the Labour Research Department. Companies were asked to state their average UK pay settlement for each year and their expected average UK pay settlement for 2025. Private sector pay settlements are a 12-month average based on monthly data.

The latest evidence from the DMP Survey is also consistent with a softening in wage growth across all sectors, to around 4% in aggregate over the year ahead. Expected wage growth in consumer services companies, in particular, remains elevated at around 5%. The latest DMP survey also asked firms about their expected response to the announced increase in employer NICs, with a number reporting they expected it to result in some downward pressure on wage growth. As outlined in Box D, however, there is evidence that suggests the NLW may act as a constraint on that adjustment within some sectors.

The outlook for inflation will also be influenced by the extent to which firms pass higher costs into prices in order to maintain or rebuild their profit margins.

While the evidence is mixed, firms appear not to have passed cost increases fully into prices in recent years (Section 2.5 in the November 2024 Report). The extent to which firms pass higher labour costs, from higher wages and increases in employer NICS, into prices in coming quarters will depend in part on the strength of demand in the economy as well as the competitive pressures they face. At present, the scope for such pass-through appears to be limited. The Bank’s Agents’ intelligence suggests that firms in consumer-facing industries expect to raise prices in 2025, though many think they will need to do so gradually so as not to disrupt sales. In addition, recent surveys suggest that firms may have to accept lower profit margins in response to the higher rate of employer NICs (Chart B in Box D).

2.6: Inflation expectations

Households’ inflation expectations rose somewhat over the second half of 2024…

Inflation expectations can influence CPI inflation through influencing wage and price-setting behaviour. The MPC monitors a range of indicators – including surveys of households and companies as well as those derived from financial market prices – to assess whether inflation expectations remain consistent with meeting the 2% inflation target sustainably in the medium term.

Having fallen significantly since the end of 2022, survey measures of household inflation expectations have risen somewhat in recent months, albeit to varying degrees. The Bank of England/Ipsos Inflation Attitudes Survey measure of median one year ahead inflation expectations rose to 3.0% in November, while the medium-term expectations measure also ticked up (left panel of Chart 2.25). The Citi/YouGov measures of households’ short-term and medium-term inflation expectations have risen more materially over recent quarters and were 3.5% and 3.7% respectively in January (right panel of Chart 2.25).

Chart 2.25: Some measures of household inflation expectations have increased over 2024 H2, though remain below their pandemic-era peaks

Measures of household inflation expectations ^{(a) (b)}

• Sources: Bank/Ipsos Inflation Attitudes Survey, Citigroup, YouGov and Bank calculations.
• (a) Left panel shows the median responses from the Bank/Ipsos Inflation Attitudes Survey. Data shown are the one-year and five-year ahead inflation expectations measures. Dashed lines represent the series averages over 2010–19. A methodological break occurred during the Covid-19 pandemic that means a degree of caution should be taken when making long-run comparisons with these data, for more information please see the methodology notes linked in the latest IAS release for November 2024. The latest data points are for 2024 Q4.
• (b) Right panel shows the monthly Citi/YouGov survey data. Data shown are the one-year and 5–10 year ahead inflation expectations measures. Dashed lines represent the series averages over 2010–19. The latest data points are for January 2025.

…however, household inflation expectations remain broadly in line with their economic drivers.

It is possible that following the recent period of high inflation households are more attentive to price rises. Google searches for the term inflation, for example, remain elevated. In addition, studies suggest that households’ inflation expectations are particularly influenced by price changes for items that they buy more frequently, such as food and energy (Anesti et al (2024), D’Acunto et al (2021) and Coibion and Gornichenko (2015)). Given the recent price rises in these components, they may be an important factor in the observed rise in household inflation expectations.

Consistent with that, Bank staff analysis suggests the developments in short-term household inflation expectations are broadly in line with what might be expected given developments in the wider economy. Chart 2.26 shows a comparison between households’ average reported expectations for inflation one year ahead and a model-based estimate of how expectations might have been expected to evolve since August 2021 based on a number of key economic factors affecting inflation expectations (in orange). The recent rises in the Citi/YouGov measure leave it broadly in line with the model-based estimate for end-2024.

Chart 2.26: Short-term household inflation expectations have largely evolved in line with economic factors

One year ahead household inflation expectations and conditional model-based forecast ^(a)

• Sources: Citigroup, ONS, YouGov and Bank calculations.
• (a) The orange line shows a forecast for one year ahead household inflation expectations from August 2021 conditional on observed economic outturns since then. The conditional forecast is estimated using a Bayesian vector autoregression (BVAR). The BVAR is conditioned on the evolution of inflation, employment, AWE (private sector regular pay), GDP and exchange rates. The latest data points shown are for January 2025.

Businesses’ medium-term CPI inflation expectations have been broadly stable…

Firms’ one year and three year ahead expectations for CPI inflation, as measured by the January DMP Survey, have fallen back from their peaks in 2022. Medium-term CPI inflation expectations have been little changed over 2024 (Chart 2.27). The Deloitte CFO survey measure of two-year CPI expectations was 2.4% in Q4, slightly higher than the 2.3% figure reported in Q3.

DMP Survey respondents’ expectation for their own price inflation in a year’s time remained elevated at around 4%, however, and has edged up slightly in recent months. This expectation is similar to firms’ reported own price inflation for the past year, suggesting that respondents do not expect much moderation in their rate of price inflation in the coming year. Intelligence from the Bank’s Agents suggests that a combination of changes to the NLW, employer NICs and the introduction of the EPR may push prices up over the next year – especially for the food and drink, hospitality, leisure and care sectors (Box F).

Chart 2.27: Businesses have reported broadly stable expectations for CPI in three years’ time

Firms’ short-term and medium-term expectations for CPI inflation ^(a)

• Sources: DMP Survey and Bank calculations.
• (a) Solid lines show three-month moving averages and dashed lines show the single-month value. One year and three years ahead CPI inflation expectations are responses to the question: ‘What do you think the annual CPI inflation rate will be in the UK, one year from now and three years from now?’. The latest data are for January 2025.

…and an indicator of market-based inflation compensation has trended down over 2024, though it remains above its pre-Covid average.

A measure of medium-term inflation compensation in financial markets has trended downwards over the course of 2024 (Chart 2.28). Some market contacts partly attributed the decline to reduced concerns around inflation persistence and the perceived restrictiveness of monetary policy. The measure remains above its 2010–19 average (Chart 2.28), with intelligence from market contacts suggesting this reflects perceptions of some continuing upside risk from inflation persistence in light of developments in services CPI inflation and pay growth.

The median respondent in the January Market Participants Survey expected CPI inflation of around 2.5% one year ahead, up slightly from 2.4% in December. Median five year ahead expectations were unchanged at 2%, although responses remain skewed to the upside of that estimate.

Chart 2.28: Five year ahead inflation compensation based on swap rates fell over 2024

RPI-reform adjusted measure of five-year, five-year forward inflation compensation ^(a)

• Sources: Bloomberg Finance L.P. and Bank calculations.
• (a) Dashed line represent the series average over 2010–19. Market-derived inflation compensation rates for average UK RPI inflation over a five-year period starting five years into the future. It is derived by adjusting the five-year, five-year rate to account for UK RPI reform. From 2030, UK RPI will be aligned with the CPIH measure of consumer prices. At present, the wedge between the current definition of RPI and CPIH affects the unadjusted series. This measure is calculated by adding a scaled market-derived estimate of the impact of RPI reform onto the unadjusted rate. That is calculated as the difference between the closest one-year forward rates before and after the planned RPI reform date (currently the four-year, one-year rate and the six-year, one-year rate) on a three-month daily rolling average basis, and the adjustment is applied to the five-year forward period impacted by the reform. The latest data are for 28 January 2025.

The MPC will continue to monitor closely developments in inflation expectations measures.

As noted in Section 2.5, CPI inflation is expected to rise quite sharply this year, accounted for predominantly by further rises in energy prices alongside a number of other regulatory changes. Although households’ inflation expectations appear to be in line with their fundamental economic drivers, there is a risk that higher expectations add to the persistence of inflationary pressures (Key judgement 3 in Section 1).