Azad Zangana, senior European economist at Schroders, comments on the latest Bank of England interest rate decision and Inflation Report
The Bank of England (BoE) maintained its key interest rate at 0.50% following the Monetary Policy Committee’s (MPC’s) meeting on 4 February. A shift in the Monetary Policy Committee’s (MPC’s) voting pattern suggests that the balance of risks on growth and inflation has shifted to the downside.
- Minutes from the MPC’s meeting suggests that the deteriorating international outlook has undermined global commodity prices and international trade
- The BoE lowered its near-term forecast not only for GDP growth, but also for inflation
- At present, the risks are skewed towards rate increases being delayed, perhaps indefinitely
There's been, in other words, no change for the 83rd consecutive month regarding interest rates – along with keeping its asset purchase facility held at £375bn.
Importantly, external monetary policy committee (MPC) member Ian McCafferty has decided not to vote for an immediate increase in the interest rate this time, having voted for an increase in the previous six meetings. He joins the rest of the committee in voting for no change. The shift in voting suggests the balance of risks has shifted to the downside on growth and inflation.
Indeed, the MPC meeting minutes suggest the worsening international outlook has adversely impacted global commodity prices and international trade and has tightened global financial conditions. These factors are likely to be having a negative impact on UK growth. The Bank not only lowered its forecast for GDP growth in the near term but also for inflation as lower energy prices are expected to keep overall cost pressures near zero for longer.
The main challenge for the BoE is to communicate a more cautious stance to the public and markets compared with November’s Inflation Report, but not to change the overall message of the economy progressing well and that interest rates are likely to rise in the future. Markets currently place a greater probability on the BoE cutting interest rates this year, and are not pricing in a rate increase until the middle of 2018.
"The main challenge for the BoE is to communicate a more cautious stance... but not to change the overall message of the economy progressing well".
The Bank, which uses the market’s path of interest rates to condition its growth and inflation forecasts, suggests the market is not pricing in enough interest rate rises and that, should the BoE follow such a path, then inflation would overshoot the Bank’s 2% inflation target two and three years out. Indeed, in the Inflation Report press conference, governor Mark Carney was keen to signal that the MPC feels interest rates are more likely to rise than not in the future.
Details of the latest Inflation Report also show the BoE expects the labour market participation rate to stabilise at current levels and for average hours worked to fall – resuming its pre-crisis trend. These suggest there is less spare capacity in the economy than previously thought.
Indeed, the BoE expects excess spare capacity in the economy to be utilised by the end of this year, which should help wages to accelerate to support household demand. The Bank’s more hawkish assessment on spare capacity also suggests the Bank is gearing up for the first rate rise since June 2007. The main obstacle to this is the anaemic rate of inflation.
Our forecast for the first rate rise is predicated on inflation being above 1% (the BoE’s lower target) and the economy growing at a steady pace. Based on our latest inflation forecast, this suggests the first rate rise may happen either around the end of the year or the start of 2017. One major difference between the Schroders forecast and the BoE’s, however, is that we forecast GDP growth to slow in 2017 on the back of accelerated austerity and higher inflation.
The BoE, on the other hand, expects growth to accelerate in 2017, from a temporary dip this year. If the Bank is right, it should continue to raise interest rates at a steady pace through the whole of 2017. If growth slows as we expect, however, the Bank may have to pause its hiking cycle or even reverse it. At present, the risks are clearly skewed towards rate hikes being delayed – perhaps indefinitely.
