Slower economic growth and higher inflation present Bank of England policymakers with a delicate balancing act when they meet this week to set interest rates and agree new forecasts for the UK as it goes through an election and Brexit talks.
The Bank’s monetary policy committee (MPC) is widely expected to keep interest rates at their record low of 0.25% to offer continued support to the economy and the jobs market.
Economists forecast that just one policymaker, Kristin Forbes, will vote for a rate rise, sticking to the position she adopted at the last meeting in March amid worries about inflation picking up too fast. The rest will opt to leave policy unchanged, according to a Reuters poll of City economists.
Alongside its decision on Thursday, the Bank will publish updated forecasts in its quarterly “inflation report”, incorporating a host of new developments since its last outlook in February. Compared with that previous report, inflation has been higher than the Bank predicted and growth has been lower as squeezed consumers rein in spending. On top of that, the government has officially opened Brexit negotiations with the rest of the EU and called a snap general election for June.
“The MPC will have to acknowledge that it is confronted with a slightly more difficult trade-off for policy-setting than previously, but we don’t foresee a change from its core neutral stance,” said Sam Hill, senior UK economist at RBC Capital Markets. Hill and other economists said policymakers could use this week’s report to nudge down their 2% forecast for GDP growth in 2017, after the year got off to a slow start. Nomura analyst George Buckley expects the Bank to signal it is in no hurry to move borrowing costs from the low they were cut to after last summer’s Brexit vote. “With economic surprises having been negative in recent weeks, the Bank looks to be in wait-and-see mode at the moment,” said Buckley.
He is forecasting interest rates will stay on hold through to the end of Mark Carney’s time as governor in June 2019. But after business surveys last week signalled the economy may have enjoyed a rebound in April, there was a risk that further positive news on growth and higher-than-expected inflation could prompt an earlier rate rise, Buckley added.
The outlook for interest rates this year is also clouded by upcoming changes on the MPC. One seat is currently empty, reducing it to eight people for this week’s decision, after deputy governor Charlotte Hogg resigned when it emerged she had breached the Bank’s code of conduct. Hogg has yet to be replaced and another position becomes free at the end of June when Forbes’ stint on the committee comes to an end.
Weighing up how the eight policymakers at this week’s meeting will vote, Victoria Clarke, an economist at Investec, noted that minutes from the March meeting in March showed worries about inflation went beyond Forbes. The rest of the committee also appeared to be more open to considering tighter policy, she said. “The minutes had a more hawkish tone that spread beyond just Forbes’s vote. They noted that ‘some members’ were of the opinion that it would not take much more upside news to justify considering tightening policy, particularly ‘on the prospects for activity or inflation’,” Clarke said.
But she expects the committee to edge back towards a more neutral stance this week, reflecting news of slower growth, weaker consumer spending, softening in the housing market and a pick-up in the pound. The currency’s sharp fall since the Brexit vote has stoked inflation by raising the cost of imports to the UK. Its partial recovery since February could ease some of that upward pressure on prices.
Kallum Pickering, a senior UK economist at the bank Berenberg, sees a case for rates rising sooner than the market is pricing in. He highlighted how the economy had confounded commentators’ gloomy forecasts for a post-referendum slump.
“While downside risks to near-term demand from Brexit uncertainty and rising inflation should be watched carefully, almost a year of data shows that these risks have failed to materialise in any serious way,” said Pickering.
Berenberg is forecasting a rate rise to 0.5% in the first quarter of 2018, with a 40% chance of it coming in 2017. “If the Bank of England waits too long it could fall behind the curve, and may face the prospect of hiking faster than would be desirable to try to bring inflation under control, and in doing so causing the negative demand shock that led to its cautiousness to begin with,” said Pickering.
Paul Hollingsworth at the consultancy Capital Economics also thinks the first rate rise will come before markets expect. “If we are right in thinking that the economy will hold up fairly well this year … and that growth remains solid next year, rather than slows as the consensus expects, then the MPC should be in a position to begin normalising rates in 2018, much sooner than most expect,” he said.