The prospect of the first interest rate rise in a decade has sent the pound to its highest level since the day after the Brexit vote and put debt-laden consumers on notice of higher borrowing costs.
The rally in the pound against the dollar provided some relief for Briton’s travelling abroad and comes amid heightened expectations that the Bank of England could increase rates as soon as November.
This would signal an end to nearly a decade of historically low interest rates. The Bank began cutting rates as the economy went into recession following the financial crisis, falling to 0.5% in March 2009. The rate remained at that level until a further cut to 0.25% in August last year following the Brexit vote. The last time there was a rise was July 2007, meaning a generation of borrowers have yet to experience a rise in their borrowing costs.
But even though expectations of a rise drove the pound higher, to $1.36, it remains almost 10% lower than on the day the polls closed on 23 Junelast year, the day of the EU referendum.
The pound had slumped to 30-year lows after the referendum – sliding to $1.20 in January – making US trips more expensive for UK holidaymakers.
The pound’s rally was prompted by remarks from a member of the Bank’s rate-setting monetary policy committee (MPC), who had previously been regarded as one of the most dovish and most wary of a rate rise. Gertjan Vlieghe, an external member of the MPC, said: “Until recently, I thought the appropriate response of monetary policy was to be patient, given modest growth and subdued underlying inflationary pressure. But the evolution of the data is increasingly suggesting that we are approaching the moment when [the] bank rate may need to rise.”
In a speech to economists in London, Vlieghe said his mood was moving towards a change in policy because of the low employment rate and a potential increase in wages in the coming months, which have put more pressure on inflation. Figures released this week showed inflation had risen to 2.9% in August.
He also warned Brexit could have a more negative impact on the economy than expected, which might force policymakers to reverse any interest rate decision.
“But for now, it seems the net effect of the many underlying forces acting on the UK economy is that slack is continually being eroded and wage pressure is gently building.
“If these data trends of reducing slack, rising pay pressure, strengthening household spending and robust global growth continue, the appropriate time for a rise in bank rate might be as early as in the coming months.”
Vlieghe, who joined the MPC in September 2015, also hinted that any change in rates might eventually be greater than the quarter point cut after the EU referendum.
His remarks echoed the sentiment of Thursday’s announcement from the MPC that rates were being held at 0.25% but that a rise was coming, although there was scepticism from some economists about the rationale behind any rise.
Economists at Bank of America Merrill Lynch said: “The possibility of a November or February hike is real, we think. That said, we cannot understand why the Bank would want to hike rates just as currency effects on inflation are about to fade, while domestic price pressure is non-existent.”
They added that the Bank “seems to be panicking about the inflation peak rather than looking ahead to the likely sharp drop next year”.
Allan Monks, an economist at JP Morgan, pointed to Vlieghe’s “positive spin on what is still a significant disappointment in the wage data”. Figures released this week showed average earnings increased by 2.1% in the three months to July.
Economists said the Bank had been having difficulty communicating its view on interest rates, which in 2014 led MPs to accuse its governor, Mark Carney, of behaving like an “unreliable boyfriend” by giving mixed messages as to when rates might move.
Economists at Barclays said they expect a rate rise in November: “We believe the MPC is ready to take the risk of a hike, even faced with disappointing data, as it has boxed itself into a corner.”