The Bank of England has today left its key policy interest rate unchanged at 0.25%. It has now been at that level for a full year. Despite widespread mutterings about hawks and normalisation, the doves are still in charge.
For the record, the official minutes show that at its meeting ending on 2 August 2017, the Monetary Policy Committee (MPC) voted by a majority of 6–2 to maintain Bank Rate at 0.25%.
The Committee voted unanimously to
- Maintain the stock of sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, at £10 billion
- Maintain the stock of UK government bond purchases, financed by the issuance of central bank reserves, at £435 billion
- Close the drawdown period for the Term Funding Scheme (TFS) on 28 February 2018, as envisaged when the scheme was introduced
Outlook assessment similar to May
The MPC’s overall assessment of the outlook for inflation and activity in the August inflation Report is that gross domestic product growth remains sluggish in the near term as the squeeze on real incomes continues to weigh on consumption.
Growth then picks up to just above its reduced potential rate over the balance of the forecast period. Net trade and business investment firm up, and consumption growth recovers in line with modestly rising household incomes.
Net trade is bolstered by strong global growth and the past depreciation of sterling. The combination of high rates of profitability, especially in the export sector, the low cost of capital and limited spare capacity supports investment by UK firms over the period.
Inflation to rise further
CPI inflation rose to 2.6% in June from 2.3% in March, as expected. The MPC says it expects inflation to rise further in coming months and to peak around 3% in October, as the past depreciation of sterling continues to pass through to consumer prices.
Conditional on the current market yield curve, inflation is projected to remain above the MPC target throughout the forecast period. This reflects entirely the effects of the referendum-related falls in sterling, say the minutes.
As the effect of rising import prices on inflation diminishes, domestic inflationary pressures will gradually pick up over the forecast period. As slack is absorbed, wage growth is projected to recover.
Squeezed margins to rebuild
In addition, margins in the consumer sector, having been squeezed by the pickup in import prices, are projected to be rebuilt. Consequently, inflation remains at a level slightly above the 2% target.
Through most of the forecast period, the economy operates with a small degree of spare capacity and CPI inflation is well above target. By the end of the forecast, the trade-off is eliminated, the minutes say,spare capacity absorbed, and inflation remains above target.
The Committee says that it judges that some tightening of monetary policy would be required to achieve a sustainable return of inflation to the target.
Tightening could be greater
Specifically, if the economy follows a path broadly consistent with the August central projection, monetary policy could need to be tightened by a somewhat greater extent over the forecast period than the path implied by the yield curve underlying August projections.
In light of these considerations, six members thought that the current policy stance remained appropriate to balance the demands of the MPC’s remit. Two members considered it appropriate to increase Bank Rate by 25 basis points.
All members agreed that any increases in Bank Rate would be at a gradual pace and to a limited extent. The Committee will continue to monitor evidence, and respond to changes in the outlook to ensure a sustainable return of inflation to the 2% target.
Downside surprise looks pivotal
Tim Graf of State Street Global Markets, courtesy of State Street
Tim Graf, head of macro strategy for EMEA at State Street Global Markets, said that the downside surprise in June inflation figures looks a pivotal event in today’s outcome, with a rate hike now looking unlikely for the remainder of this year, probably much longer.
He adds: “Indeed, our gauges of online retail inflation, showing sharp deterioration in annual inflation rates, suggest the MPC can afford to wait and see if political uncertainty takes any further toll on already softening growth and inflation data.”
Alan Wilson, senior investment manager of active fixed income at State Street Global Advisors, said the Bank continues to walk the policy tightrope, balancing transitory inflation pressure against concerns Brexit uncertainty will eventually curtail domestic growth.
All eyes on Super Thursday
Today, all eyes were on Super Thursday; would there be an intensification of the hawkish signalling we have seen over recent weeks?, he asked.
“From today’s release, it is clear hawkish discontent has been somewhat tempered – weaker than expected growth, wage and consumer data since June’s meeting has given like-minded committee hawks food for thought.
“Looking forward, the MPC will maintain its hawkish bias to encourage the market to dampen inflation expectations on its behalf. It is very unlikely this signalling will culminate in formal policy action, particularly in the early stages of the Brexit process.
Learning lessons from the European Central Bank (ECB), the MPC will continue to tread lightly and resist the temptation of tightening amid transitory inflation pressure, Wilson concludes.
Lamb to the slaughter
David Lamb, head of dealing at FEXCO Corporate Payments, says: “The pound has been hit by a dovish double whammy. The Monetary Policy Committee has returned firmly to type, with an increased number of rate-setting grandees voting for the dovish orthodoxy.
“And with the Bank’s Inflation Report predicting both a slowdown in economic growth and continued rising inflation, the doves are now set to rule the roost for the foreseeable future. Translation – we shouldn’t expect an interest rate rise at least until the start of 2018.
“The combination of these signals prompted the pound to lose most of the gains it made against the dollar earlier this week, he comments. Meanwhile it is in full retreat against the euro, sliding to its lowest level for nine months.
With the MPC so wary of derailing Britain’s fragile growth with a rate rise – and the Bank forecasting further economic weakness – the prospects of a rate hike have once again disappeared over the horizon, he adds. Sterling’s brief spell of strength has sunk with them.
With the MPC so wary of derailing Britain’s fragile growth with a rate rise – and the Bank forecasting further economic weakness – the prospects of a rate hike have once again vanished over the horizon. Sterling’s brief spell of strength has sunk with them, says Lamb.
On the flip side
Martin Palmer, head of corporate market management at Zurich, says: “Despite edging closer towards a rate hike at end of the year, the side step today means a continuation of the record lows that have driven borrowing and supported mortgage repayments.
“On the flip side, it means less return on savings at a time when inflation has been on an upward trend, so while some people may be starting to build up cash reserves, these will lose more and more value in real terms as time goes on.”