BoE's Taylor: Upside scenario centers on productivity question

BoE's Taylor: Upside scenario centers on productivity question

BoE’s Analysis: Productivity Crucial to Economic Outlook

The Bank of England's recent Forecast Evaluation Report highlights the pivotal role of productivity in shaping the UK's economic trajectory, particularly as policymakers assess upside scenarios amid persistent inflation and labor market challenges. The report underscores that while external shocks—such as energy price volatility and global supply disruptions—have historically driven forecast errors, structural factors like productivity growth are increasingly critical to long-term stability.

Productivity weakness, identified as a key contributor to elevated costs for firms, has complicated efforts to rein in inflation. The Bank notes that weaker productivity growth since 2021 has reduced potential supply, narrowing spare capacity and intensifying inflationary pressures. This dynamic has forced the Monetary Policy Committee (MPC) to recalibrate assumptions about economic resilience, particularly as wage growth remains stubbornly high despite tighter monetary policy.

The report also emphasizes that improvements in productivity could unlock growth while easing inflationary tensions. However, such gains depend on resolving structural bottlenecks, including labor market rigidities and the lingering effects of post-pandemic disruptions. The Bank's updated COMPASS model now incorporates enhanced energy price dynamics and faster monetary transmission mechanisms to better capture these interdependencies.

Data revisions and measurement challenges further complicate productivity assessments. For instance, initial GDP and wage growth estimates since 2021 have been upwardly revised, skewing near-term forecast accuracy when evaluated against later data vintages. The Bank acknowledges the need for improved data quality, particularly in labor market statistics, to refine future projections.

Looking ahead, the Bank's ongoing modeling upgrades and expanded scenario analysis aim to address uncertainties around productivity and supply-side dynamics. While external shocks remain unpredictable, the report stresses that resolving productivity gaps will be central to achieving the 2% inflation target and fostering sustainable growth.

For investors, the BoE's focus on productivity underscores the importance of monitoring structural reforms, labor market developments, and corporate efficiency measures as key drivers of the UK's economic outlook.

(https://www.bankofengland.co.uk/paper/2026/forecast-evaluation-report-january-2026): Bank of England, Forecast Evaluation Report – January 2026.