Interest rate rise closer than markets think, hints BoE
THE Bank of England surprised markets by indicating that interest rates could go up sooner and more quickly than expected, as it said hikes may be needed to keep inflation under control.
Mark Carney and the Monetary Policy Committee (MPC) kept interest rates on hold at 0.25pc, but said investors did not fully appreciate that rates could rise “over the coming months”.
Sterling rose by 1pc against the dollar to $1.3341 as a result.
The MPC voted by a margin of seven members to two against changing rates, arguing that the Bank of England should be supporting economic growth and employment at a time of economic uncertainty. Inflation is currently running at 2.9pc, well above the Bank’s target of 2pc, but is expected to peak soon, meaning policymakers do not feel compelled to step in with higher interest rates to control prices.
“The circumstances since the referendum on EU membership, and the accompanying depreciation of sterling, have been exceptional,” said the minutes of the meeting. “The MPC’s remit specifies that, in such exceptional circumstances, the committee must balance any trade-off between the speed at which it intends to return inflation sustainably to the target and the support that monetary policy provides to jobs and activity.”
The minutes also noted that the balance of the trade-off could change in the near future. “If the economy follows a path broadly consistent with the August Inflation Report central projection, then monetary policy could need to be tightened by a somewhat greater extent over the forecast period than current market expectations,” the MPC meeting said. If slack in the economy is used up and inflation rises, “some withdrawal of monetary stimulus is likely to be appropriate over coming months in order to return inflation sustainably to target”.
Economists believe this could mean rates will rise this year. “If the economy continues to hold up, and there are clearer signs that wage growth is building, the first hike could come somewhat earlier than we had envisaged,” said Paul Hollingsworth at Capital Economics.
‘Monetary policy could need to be tightened by a somewhat greater extent than market expectations’
MARK CARNEY was accused of being an “unreliable boyfriend” by Pat McFadden MP back in 2014.
At the time the criticism was levelled at the Bank of England’s shifting guidance. It had suggested that interest rates could rise in 2014. And then 2015. And then 2016. And yet rate hikes came there none. In fact, interest rates are now lower than ever. So, how should we take the latest hints that rates could rise? Is the Governor serious, or is something more complicated going on?
Some analysts have suggested the Bank is trying to persuade the markets rates will rise to boost the pound, which will help reduce inflation and thereby negate the need for a rate rise. It’s quite a complicated game. And the key to its success is the extent to which the market feels it can trust the Bank. The trouble is, the markets have been let down several times. In 2013 Carney arrived in Britain and said he would consider raising rates when unemployment fell below 7pc. He thought it would take three years, but in fact it took only six months. Unemployment is now 4.3pc, but rates are lower than four years ago.
In October 2015, the Governor told households that the Bank was “focused… [on] raising interest rates” and that they should prepare for higher borrowing costs. Three months later he ruled it out, saying inflation was lower than expected and so there was no need to tighten policy.
Policymakers then signalled that they could raise rates around a year later to prevent the economy from overheating. Any move in that direction was thrown off course by the Brexit vote in June 2016; the Bank responded to this by cutting rates the following August. By October last year, MPC member Gertjan Vlieghe acknowledged that raising rates would ensure inflation was on target at 2pc in 2019. But he warned that the price in terms of lost economic growth and jobs was too high, so rates should stay on hold for the foreseeable future. Six months later, rate rises were back on the agenda. Three MPC members voted for a hike in June and chief economist Andy Haldane said he considered following suit.
The Governor said rising business investment could show the economy was performing well and allow for rates to rise. The pound rose. But in August the MPC voted to hold rates and cut growth forecasts. The pound fell. Yet now the MPC is talking once more about the potential need to raise rates. What should markets think?
Analysts wonder if this is a tactical ploy. HSBC believes central banks are using words rather than rate changes to push the currency up, testing the effect on inflation and growth in a way that is easily reversible before moving on to actual hikes.
BNP Paribas sees little benefit in a single rate hike and no prospect of a sustained series, leaving its analysts with the view that this is a bluff. Markets moved on the committee’s statement, so it had some short-term effect at least. But policies conducted by means of rhetoric may only work so long. Soon investors may start to suspect the Governor is bluffing.
Even this latest announcement has only pushed the market’s expectation of a rate rise this year to 55pc. That is twice the level at the start of the week. But it also suggests that investors are far from convinced – and perhaps rather confused.