First the expected stuff…
The MPC voted unanimously (9-0) to keep base rates on hold at 0.5% following November’s hike. No surprise here.
But we may not have to wait long for a hike…
While rates weren’t raised this time, the Inflation Report and Governor’s press conference has given us a fairly strong indication that they will be raised sooner rather than later. Indeed prior to today’s decision markets had been anticipating one rate rise towards the end of 2018; the following paragraph from the Inflation Report however looks to cast some doubt on this and hint at an earlier hike, be it in August or even May.
“The Committee judged that, were the economy to evolve broadly in line with the February Inflation Report projections, monetary policy would need to be tightened somewhat earlier and by a somewhat greater degree over the forecast period than anticipated at the time of the November Report”
This paragraph was then followed up with “future increases in Bank Rate are expected to be at a gradual pace and to a limited extent”. A tad confusing and what exactly this meant was put to the governor. It turns out “gradual” means there won’t be two rate hikes a quarter as has been the case in previous periods of normalisation, while “limited” means rates won’t be rising to the lofty 5% level any time soon (the average across the UK pre crisis). This therefore leaves open the prospect of a couple of rate hikes, both by 0.25pp, in 2018...
Why the change in tone?
Firstly the economy is performing reasonably well. In fact the Bank has raised its growth forecasts for the UK up to 1.8% for both 2018 and 2019, up from 1.6% and 1.7% respectively in November. Much of this growth is being attributed to the strong global economy with healthy growth rates expected to be maintained across the Eurozone and US over the coming year. This in turn should continue to boost trade, with UK exports continuing to enjoy a sweet spot, on the back of strong global demand and a weak currency.
On the other hand however, business investment while growing is set to remain weak as Brexit uncertainty continues to take hold. The Bank helped highlight this in the Inflation Report using our own Investment Monitor data, where we found that just under half of manufacturers’ investment plans were being negatively impacted by Brexit. Meanwhile consumption is also forecast to grow at a slower rate than the economy as a whole as households adjust to weak growth in their real incomes, and elevated price levels. This of course is all occurring against a backdrop of political and economic uncertainty, which is likely to be ramped up the closer we get to the 2019 EU-leave deadline. Therefore while the economy is growing, we are not enjoying the global upturn to the same extent as our international counterparts.
What about inflation?
With the economy moving along at a, if not barnstorming, steady speed, and the Bank stating that very little slack remains in the economy on the back of a strong labour market, naturally our attention turns to inflation, and the ability of the economy to grow without generating inflationary pressures.
The latest inflation data saw the CPI fall to 3%, and it had been expected that inflation would steadily fall through 2018 as the effect of sterling’s depreciation became exhausted. Since November however, the rise in oil prices, and associated rise in energy and fuel prices has meant the Bank’s near term inflation projections have risen. These external cost pressures are set to be boosted, as domestic cost pressures firm, with wages finally expected to see some significant upward movement.
The peak in inflation therefore may not be behind us, with the Governor himself saying prices could rise back up above the 3% mark in 2018.
What’s our takeaway?
The hawkish tone evident throughout the minutes and Inflation Report, combined with inflation’s higher than anticipated trajectory, would suggest that a rate hike is perhaps closer than we may have previously anticipated – with a tightening in August or May looking likely. How the data evolves over the coming months however, and in particular wage data from the January pay rounds, will be key in determining this, and the Bank should look to signal imminent rises to the markets. We ourselves are chewing over our own forecasts at the moment which will be out in March, and will be looking to our own Pay Bulletin for signs of the much heralded wage pressures.