Get ready for higher rates: Bank of England upgrades growth forecasts and signals hikes are on the way

Bank of England Governor Mark Carney speaks during the central bank's quarterly inflation report press conference in the City of London, Britain, February 8, 2018.

caption
Bank of England Governor Mark Carney speaks during the central bank’s quarterly inflation report press conference in the City of London, Britain, February 8, 2018.
source
Reuters/Victoria Jones

  • The Bank of England left interest rates unchanged at 0.5% on Thursday in its first monetary policy decision of 2018
  • The rate was widely expected to remain unchanged, although the bank is expected to raise rates once or twice this year.
  • Bank signalled that interest rates could now rise faster and to a greater extent than previously expected.
  • Alongside rate decision, the bank raised its forecasts for the UK’s growth prospects in both 2018 and 2019.

LONDON – The Bank of England left interest rates unchanged at 0.5% at the first meeting of its Monetary Policy Committee (MPC) in 2018, it was announced on Thursday.

The MPC voted unanimously in favour of leaving rates unchanged. The bank’s quantitative easing programme also remained unchanged, with a cap of £435 billion on its asset purchases.

While policy was widely expected to remain unchanged, the bank made clear that it is ready for rate hikes in 2018, saying that policy could be “tightened somewhat earlier and by a somewhat greater extent over the forecast period” if the economy continues to grow as forecast.

“It will be likely be necessary to raise interest rates to a limited degree in a gradual process, but somewhat earlier and to a somewhat greater extent than what we had thought in November,” Governor Mark Carney said in a press conference following the decision.

The bank released its Quarterly Inflation Report alongside the monetary policy decisions. In it, the central bank upgraded its forecasts for UK economic growth in both 2018 and 2019.

The Bank of England now expects UK GDP to expand by 1.7% in 2018, compared to a previous forecast of 1.5% made in November. Growth in 2019 is expected to be 1.8%, compared to a previous forecast of 1.7%.

Markets currently expect at least one, and possibly two, interest rate increases in 2018.

After hiking rates for the first time in a decade last year, the Bank spent much of the rest of the year signalling that it will likely raise rates further in 2018. The market expects those hikes to come towards the end of the year, with either August or November seen as the most likely times.

Today’s release suggests that the bank is considering a hike in May, the next time it releases an Inflation Report.

Despite the bank’s language, Carney was keen to emphasise that there is no set path for rates.

“We’re not going to tie our hands to a specific path for rates going forward. We are reiterating that these interest rate cycles are unlike those we would’ve experienced in the past,” he said in a post-decision press conference.

The announcements “suggest that despite the recent upward revision to markets’ interest rate expectations, they may not have gone far enough,” Paul Hollingsworth, senior UK economist at Capital Economics said in a note to clients/

“Even though recent UK economic growth has been subdued, our economy will receive continued support from strong global growth in 2018,” Andrew Sentance, a senior economic adviser at PwC, and a former MPC member added.

“All the three main engines of the global economy – US, Europe and Asia – are performing well this year, and we are now in the best phase of global economic growth we have seen since the financial crisis.

“All this points to rising interest rates, both here in the UK and in other major economies.”

Brexit remains the biggest cause of uncertainty in the UK economy, the Bank of England added, referring to “Brexit-related uncertainties” four times in the minutes of the MPC meeting.

“Developments regarding the United Kingdom’s withdrawal from the European Union – and in particular the reaction of households, businesses and asset prices to them, remain the most significant influence on, and source of uncertainty about, the economic outlook,” it said.

Sterling jumped on the announcement, with expectations of more rate hikes bullish for the UK’s currency. By 1.30 p.m. GMT (8.30 a.m. ET), the pound was up by around 1.1% against the dollar to trade above $1.40:

Screen Shot 2018 02 08 at 13.28.00

source
Markets Insider

The growth picture

The economic picture in the UK right now is somewhat murky. Backwards looking indicators (those which take into account actual hard data) are reasonably positive, with the UK’s GDP in the fourth quarter growing at 0.5% – better than had been forecast. Inflation, which is the bank’s biggest concern when setting rates, has also started to fall.

However, forward looking indicators are much less positive. Indicators like IHS Markit’s PMIs, which rely on some hard data, but also on the future expectations of survey participants, have been universally disappointing in 2018. All three of the PMIs – for the services, manufacturing, and construction sectors – have come in worse than expected at the start of the year, with the construction sector in a particularly troubling state.

The sector is “teetering on the edge of contraction,” and possibly heading towards recession in 2018.

“The pace of UK economic growth slowed sharply at the start of the year as January saw a triple whammy of weaker PMI surveys,” Chris Williamson, IHS Markit’s chief business economist said in a statement.

The Bank of England’s judgement is that while the domestic picture will remain reasonably strong, the economy will also be dragged higher by the strength of the global economic recovery.

“Growth has picked up significantly across many economies over the past two years. The outlook for global growth appears to have strengthened somewhat further over the past three months,” the Inflation Report said.