UK interest rate rise is coming, Bank of England tells borrowers

Decision to hold rates now came with heavy caveats that a rise is likely in May to tackle inflation

The Bank of England has signalled that an interest rate hike is coming from as early as May and that there are more to come, as the economy accelerates with help from booming global growth.

Threadneedle Street said it would need to raise rates to tackle stubbornly high inflation “somewhat earlier and by a somewhat greater extent” than it had anticipated towards the end of last year.

While the Bank’s rate-setting monetary policy committee (MPC) voted unanimously to leave rates at 0.50% this month, the tone of its discussion suggests the cost of borrowing will not remain this low for much longer.

The Bank’s governor, Mark Carney, had previously suggested there could be two further rate hikes to curb inflation over the next three years – but speculation will now mount over the chance of additional rate hikes.

The pound rose on foreign exchanges following the interest rate decision, hitting almost $1.40 against the dollar. City investors give a 75% chance of a rate hike in May, after having previously given a 50-50 probability.

The FTSE 100 sold off sharply, falling by more than 108.7 points to below 7,200, amid a global stock market rout triggered by concerns among investors that central banks will need to raise interest rates faster than expected to curb rising inflation. On Wall Street, the Dow Jones Industrial Average was down more than 400 points by lunchtime.

Threadneedle Street said inflation would fall more gradually than it had previously anticipated, because workers’ pay is slowly beginning to pick-up and as the oil prices is rising. “The outlook for growth and inflation [is] likely to require some ongoing withdrawal of monetary stimulus,” the MPC said.

Although the consumer price index reached 3.1% in November and is forecast to fall over the coming year as the effects of the weak pound following the Brexit vote begin to fade, the Bank said it is likely to remain above the 2% target.

Writing to the chancellor, Philip Hammond, to explain why inflation was more than one percentage point outside the government’s target, Carney said it was now “appropriate to set monetary policy so that inflation returns sustainably to its target” after previously having left the rate unchanged to support jobs and growth.

A sustained upswing in global economic activity over the past year – led by the eurozone and stronger growth in the US and China – has helped to prevent a sharper Brexit-related slowdown in Britain.

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Andrew Sentance, senior economic adviser at PwC and a former member of the MPC, warned that rates could rise up to three times this year as a result of inflationary pressures and global growth. “All this points to rising interest rates, both here in the UK and in other major economies.” He added: “It is still likely that we will see at least one quarter point rise in 2018 and possibly two or three.”

Ben Brettell, senior economist at Hargreaves Lansdown also said the drive to constrain inflation meant “rates could rise faster and further than investors had expected.”

Britain grew at its fastest rate in 2017 in the final quarter of the year, after a slump prompted by a slowdown in consumer spending earlier in the year, but is now forecast to rebound with the help of global trade. That is despite tough conditions for British households under intense pressure since the Brexit vote as the weak pound pushes up the cost of importing food and fuel.

Brexit uncertainty has constrained the speed at which the UK can grow before prices begin to spiral, according to the Bank, which said the growth potential of the economy had been clipped below the levels it was able to achieve in previous years.

Threadneedle Street reckons the annual supply capacity of the economy can only rise by about 1.5% before generating increased inflationary pressures, but estimates GDP growth will average about 1.75% each year until 2021.

Worries over rising inflation have spooked financial markets in recent weeks, pushing up bond yields and triggering a sell-off in shares, as investors speculate how fast central banks will tighten monetary policy. Although most of the focus has been on the Federal Reserve and the arrival of its new chairman, Jerome Powell, the Bank’s latest inflation report is likely to have fuelled fears in the City.

The MPC said it was too early to gauge how large and persistent market corrections were likely to be. “Notwithstanding recent volatility in financial markets, global financial conditions remain supportive,” it added.

Contributor

Richard Partington

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