Bank of England votes 7-2 for no-change

The Bank of England, as predicted by City analysts, left UK interest rates on hold 0.5% today. Which means this morning’s meeting needed to lay some grit and sand for what must be an inevitable May interest rate hike.

Did they – and what gaps were filled? First, a rate rise looks a dead cert for the next 10 May monetary policy committee meeting (there’s no meeting in April). 

An “ongoing tightening of monetary policy over the forecast period would be appropriate to return inflation sustainably to its target at a more conventional horizon,” the Bank of England said in its statement. 

There was also agreement future rate climbs would be “at a gradual pace”. But pressure for a May hike is being fuelled by impatience from MPC committee members Michael Saunders and Ian McCafferty who want a rate increase now to swerve possible hastier moves upwards later.

Carney has set the scene for a May rate hike: credit; Policy Exchange

Slack is narrowing – Saunders and McCafferty

Both Saunders and McCafferty saw “widespread evidence that slack was largely used up and that pay growth was picking up, presenting upside risks to inflation in the medium term”, the minutes noted. Both were out-voted by the seven other members, including Governor Mark Carney.

Earlier this week February headline inflation fell to 2.7% from 3%, the lowest figure since last July. Core inflation – the measurement which strips out more volatile goods like energy prices – dipped to 2.4% from 2.7%, more than expected. 

However those slipping inflation figures were more or less brushed aside by chief economic adviser to the EY ITEM Club Howard Archer. He warned that falling inflation would “make little difference to the monetary policy outlook and we expect this week’s meeting to prepare the ground for the MPC to hike rates again in May”. As they clearly have.

Inflation still remains way above the Bank of England’s preferred 2% benchmark target. When Britain voted to exit the EU, inflation was hovering at just 0.8% and close to zero preceding that – though the Brexit vote changed that, seeing inflation rise to a 3.1% high last November. But a steadily recovering pound means inflation, to some extent, is being steadily flushed out of the system.  

Inflation pre-Brexit vote was substantially lower than November 2017: Shutterstock

Wage growth is on the up – at last

Fast forward to early 2018 and UK worker pay is rising, finally, and faster than expected – as Michael Saunders and Ian McCafferty warned at midday. This week the Office of National Statistics said UK pay inflation surged to a two-year high in the three months to January, signaling the end of close to 12 months of falling worker spending power, once inflation is absorbed. 

The ONS also confirmed overall earnings climbed 2.8%, improving on a revised 2.7% figure for the quarter to December (the January figure needs to be treated with a measure of skepticism as the start of the year sucks in bonus-related wage numbers; excluding bonuses, earnings came in at 2.6% growth). 

“The firming of shorter-term measures of wage growth in recent quarters,” said the Bank of England this morning, “and a range of survey indicators suggest pay growth will rise further in response to the tightening labour market. This provides increasing confidence that growth in wages and unit labour costs will pick up to target-consistent rates.”

Adding to the positive mood came news this week that the number of those in work expanded by almost 170,000; many economists had anticipated a figure close to half that. And while fourth-quarter GDP was revised down the ONS claims the UK economy grew 1.7% during 2017 (though this is well below the long-term historical UK average).

Wage growth is badly needed given the rising pressures of UK transport costs: Shutterstock

Services sector optimism helps

All this accumulated economic data points to some easing of inflationary pressures following the crushing impact of the Brexit vote and the consequent hammering of the pound, pushing shop food prices higher. 

Progress on a Brexit transitional deal also supplies the Bank of England with a chunk or two of extra political certainty it didn’t have before. Adding more support, the UK services sector – which carries around 80% of total UK GDP – hit a four-month industry high in February, according to the latest purchasing managers’ index. 

A more bullish services economy, then, has to give Bank of England Governor Mark Carney and his nine-person team more impetus for paced rate hikes (there’s supplementary support from the US Fed which yesterday raised rates, again) from May. 

But, as the Bank indicated at midday, it will be almost certainly be baby steps. While UK retail sales lifted strongly in February by 0.8%, more than expected (most economists had penciled in a 0.4% climb), much of the February sales lift was down to supermarket sales growth rather than broader high-street shopping (bear in mind the demise of Maplin and Toys R Us). 

The close of Maplin adds more worry to UK bricks-and-mortar high street shopping: Shutterstock

FTSE 100 slips, sterling rises

Ben Brettell, senior economist at Hargreaves Lansdown, says keep the champagne on ice for the moment. He warns there’s a risk of further disappointment in March thanks to the surprise appearance of the Beast from the East bringing economic disruption, keeping many consumers off the high street. 

Given no monetary policy committee (MPC) meeting in April, today’s meeting is the last till 10 May. Sterling leapt to a 7-week high following the midday Bank of England rate decision news to $1.420 against the US dollar and to €1.151 against the euro.

The export-reliant FTSE 100 slumped more than 1% to 6,955 points at 12.30pm with Micro Focus International and Schroders down -6.64% and -2.86% respectively.