By Daniel Grote of Citywire
The Bank of England appears to be in no rush to raise interest rates despite upping its forecasts for UK growth and inflation.
Members of the Bank’s monetary policy committee (MPC) voted unanimously to keep interest rates on hold at 0.25%, and the Bank’s forecasts assumed no hike until the end of next year.
‘Despite market expectations of a hawkish shift, the Bank of England kept the neutral policy bias introduced in the last meeting, emphasising that policy can respond “in either direction”,’ said Anna Stupnytska, global economist at fund group Fidelity.
This was despite the Bank forecasting inflation peaking at 2.8% in the first half of 2018, powered by the pound’s heavy fall following the Brexit vote, and a big upgrade to its growth forecast for this year.
In its Inflation Report the Bank estimated growth would hit 2% this year, up from its 1.4% forecast in November and more than double the 0.8% growth it predicted in the immediate aftermath of the Brexit vote.
The Bank cut interest rates to a new record low of 0.25% and relaunched quantitative easing following the Brexit vote, in a bid to counter a feared downturn in the UK economy.
But since then the UK economy has proved more resilient than the Bank had expected. Since its last Inflation Report in November, the UK’s services sector has enjoyed five consecutive months of growth, with a sharp jump in November, retail sales have risen and unemployment has remained at an 11-year low.
Carney insists Brexit response ‘correct’
Bank of England governor Mark Carney said the Bank had underestimated the resilience of UK consumers following the Brexit vote.
‘The thing that we missed is the strength of consumer spending and consumer confidence associated with that – that has been present all the way through this process,’ he said.
‘After an initial wobble in terms of consumer surveys, confidence surveys and other initial indicators in the immediate aftermath of the referendum in the depths of the summer, it bounced back pretty quickly.’
But he insisted the Bank had made the ‘correct’ move in cutting rates and relaunching stimulus in the aftermath of the vote. ‘Last summer’s circumstances were exceptional. And we believe the decisions we took were correct, which is why we’ve just confirmed our policy stance today,’ he said.
With inflation’s rise following the Brexit vote forecast to strengthen, the Bank said in minutes from its MPC meeting that there were ‘limits to the extent that above-target inflation can be tolerated’.
But markets are currently pricing in less than a 40% chance that the Bank will raise rates this year, with a hike in 2018 seen as much more likely.
Ben Brettell, senior economist at Hargreaves Lansdown, said investors were right to be sceptical, dismissing a rate rise this year as ‘improbable’.
‘The most likely scenario is that higher inflation and weaker pay growth will squeeze household budgets, meaning consumer spending is likely to slow in real terms,’ he said. ‘The Bank is unlikely to take the risk of raising borrowing costs in this environment.’
James Knightley, senior economist at ING, said he didn’t expect rates to rise until 2019. ‘We are less optimistic on activity than the Bank of England,’ he said. ‘We expect growth to slow to 1.5% this year from 2% in 2016. Employment has fallen in the last two monthly reports while business surveys point to a moderation in investment intentions.
‘Consumer confidence has weakened in response to rising inflation, which is likely to erode household spending power, while consumer credit has taken a notable downturn.’
Change to ‘equilibrium’
Kathleen Brooks, research director at currency broker City Index , said the Bank had given itself more scope for delaying an interest rate rise with a significant change in its report.
She said the Bank had lowered its ‘equilibrium’ rate of unemployment that the economy could bear without creating inflationary pressures to 4-4.75% from 5%.
‘Right now the UK’s unemployment rate stands at 4.8%, which means that it could fall substantially further before it leads to stronger wage growth and thus threatens the Bank of England’s inflation target,’ said Brooks.
Stupnytska said that rather than raising rates, she saw the Bank erring on the side of easing policy this year. ‘I believe monetary policy will become more accommodative as we move through the year, as it is forced to lean against the headwinds of Brexit-related uncertainties,’ she said.
‘In this respect, I still expect policy to become more accommodative, potentially via the reintroduction of quantitative easing later in the year.’
Hawks spy MPC tensions
But Adam Chester, head of economics at Lloyds Bank Commercial Banking, disagreed that an interest rate rise was a distant prospect. He said it was clear some MPC members were becoming more concerned about inflation given the economy was doing well and the pound remained 16% below its pre-referendum level.
‘Today’s report is likely to add to perceptions that the emergency rate cut last August is no longer justified. If the economy continues to hold up well, a rise in interest rates before year end could be on the cards.’
Lucy O’Carroll, chief economist at Aberdeen Asset Management, said Carney’s two challenges were to anchor forecasts on the real economy and to handle tensions within the MPC over how much inflation could be tolerated.
‘Mr Carney has used today’s events to signal that the Bank’s next interest rate move will probably be a hike.
‘It’s hard to understate how much of a turnaround that is from where we were in the immediate aftermath of the EU referendum. The Bank’s post-referendum rate cut was an attempt to pre-empt a downturn that hasn’t occurred,’ she said.