The Bank of England (BOE) has signaled the need for interest rate rises earlier and potentially more frequent than previously predicted, preparing markets for impending higher borrowing costs.
In its first meeting of 2018, the Bank’s Monetary Policy Committee (MPC) judged that, were the economy to move broadly in line with its projections, “monetary policy would need to be tightened somewhat earlier and by a somewhat greater extent over the forecast period,” than anticipated during its last report in November. This would be required to “return inflation sustainably” to its target and over a “more conventional horizon,” the report said.
Sterling spiked against the dollar on the news as higher rates in an economy tend to favor the local currency with the anticipation of more investment. The pound nearly hit 1.400 against the greenback after trading close to 1.388.
At the same time, the Bank voted unanimously to keep interest rates unchanged in January.
The rate decision and hawkish comments come on the back of significantly improved global growth, a modest improvement to the U.K.’s growth outlook and increasing domestic cost pressures as wages look to rise.
The BOE noted that the market believes that interest rates could reach 1.2 percent by 2021, suggesting three rate hikes in that period. However, this would still leave inflation above target which hinted at a possible hiking cycle that was quicker than investors were expecting. BOE Governor Mark Carney insisted in his subsequent press conference that any rate moves would be gradual.
He added that rates would not move more rapidly, but that the message to markets was that they could move somewhat sooner and to a somewhat greater extent.
“We’re not going to tie our hands to a specific path for rates going forward. We are reiterating that these interest rate cycles are unlike those we would’ve experienced in the past,” he told the media.
The MPC once again stressed its remit to strike a balance between providing an accommodating monetary policy that supports economic activity while at the same time returning the U.K. to a target inflation rate of 2 percent.
U.K. inflation is still far above the target, and in November hit a five-year high of 3.1 percent, mainly due to the stark depreciation in sterling since the June 2016 Brexit vote. It has since moved to 3 percent.
A higher outlook for wages as well as the low level of “slack” in the economy, appears set to continue squeezing prices and propping up inflation.
But the Bank believes inflation will gradually subside over its three-year forecast, though will remain around current levels for at least the next few months as domestic cost pressures continue to build, energy prices rebound and imports remain expensive thanks to the weaker pound. It does not project a return to the 2 percent target in the next three years.
Incoming data for the country’s economy has still been mixed since the MPC’s last meeting in December 2017, when the committee voted unanimously 9-0 to leave rates unchanged while expressing its intention of “further modest increases in Bank Rate … over the next few years.”
The BOE hiked rates in November of 2017 for first time in over a decade, voting to increase the benchmark rate from 0.25 percent to 0.5 percent as part of what it called a “gradual and limited” cycle to counter inflation.
While seeing the best signs of recovery since the June 2016 Brexit vote, the country’s growth still lags behind that of its main trading partners amid a broadly-based global upswing. Fears remain that domestic politics and uncertainty over Brexit outcomes could still impede a re-joining of this faster global growth.
As in previous inflation reports, the Bank emphasized that … “Developments regarding the United Kingdom’s withdrawal from the European Union — and in particular the reaction of households, businesses and asset prices to them, remain the most significant influence on, and source of uncertainty about, the economic outlook.”
