Ben Broadbent: Rate rise may be higher than market expects

Ann Santiago
August 6, 2017

In its quarterly inflation report, the Bank of England lowered its GDP growth forecast for 2017 to 1.7% from 1.9% with the 2018 projection shaved to 1.6% from 1.7%. Inflation was forecast to peak at 3 percent in October and to fall to 2.8 percent next year. Growth in the 19-member single currency bloc was 0.6 per cent, double the 0.3 per cent estimate for the United Kingdom from the Office for National Statistics last week.

That had a knock-on effect on sterling.

Today the Bank voted to keep rates at 0.25 per cent, by a margin of six votes to two.

British inflation in June stood at 2.6 per cent and the BoE's latest forecasts see it remaining above its 2 per cent target throughout its three-year forecast period.

At its simplest level, the policy dilemma facing Britain's central bank is that it must balance surging inflation brought on by the weakened pound since the referendum with the slowdown in the economy, dwindling consumer spending, and declining inward investment. The speed limit, if you will, of the economy has slowed... This would mean the gap between supply and demand would fall and consumers would have less to spend on goods/services, which makes them cheaper.

While rates are on hold for now, the bank warned they may eventually rise more quickly than markets seem to expect. "The immediate threat of higher interest rates (which would, in turn, bring sterling strength) has passed, allowing United Kingdom exporters to continue to use their exchange rate-induced price advantage when selling overseas". The MPC now sees growth at 1.6 percent in 2018, down from 1.7 percent, while GDP in 2019 remains at 1.8 percent.

On the Brexit front, Carney said that uncertainty over the UK-EU future relationship is weighing on business investment and household spending, adding that the level of investment in the economy is now expected to be 20% lower than the Bank anticipated before the vote to leave the EU.

But a raft of weaker data - as well as deep uncertainty about the impact of Brexit - called that view into question.

It also comes amid the first strike by Bank of England staff for 50 years, with members of the Unite union protesting over a below-inflation wage rise.

"Of course, it could perhaps be that traders are only concerned with the near-term expectations of the BoE given its history of bad forecasts and the sheer amount of uncertainty in the economic outlook due to Brexit".

This has led to the rise in inflation, as prices reflect the higher costs of imports and of commodities and raw materials for manufacturers.

The decision to increase rates may have been dismissed for this month, however, the Monetary Policy Committee believes that it is "possible" for an increase in interest rates later this year.

Rising levels of household debt could leave Britain's lower-income families dangerously exposed amid signs of an economic downturn linked to Brexit, Moody's credit rating agency said in his report published on Tuesday.

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