The Bank of England is expected to report today that in light of the UK economy growing faster than anticipated in the run up to Brexit, another interest rate rise could be on its way this year.
The Bank raised rates for the first time in more than a decade in November, reversing a cut made in 2016 as the country felt the impact of the EU Leave vote – rates then were cut 0.5%.
While the UK still faces numerous economic challenges, it has fared better than most forecasts made at the time of the Brexit vote, and it ended 2017 stronger than the central bank expected.
The BoE the is widely expected to keep rates on hold today as it weighs up the impact of November’s rate rise on the economy.
Investors will be keen to see if any of the nine rate-setters at the MPC meeting vote for a hike. That would be a sign that a rate increase in May would be more likely, May is when the BoE is due to update its economic forecasts.
Two rate rises?
According to Reuters, investors see a 50-50 chance of a new hike in May and some economists are predicting two increases this year alone. That would represent a big change from the BoE’s signal as recently as November of just two hikes over the next three years.
Of course, any rise in interest rates will depend on UK economic growth and while it may have surprised the BoE on the upside, it is in a very fragile position with Brexit looming.
Much will depend on the UK’s attempt to negotiate a new trade deal with the EU, its main trading partner.
As UBS fixed income strategist John Wraith told Reuters: “Although the MPC won’t explicitly say so given political sensitivities, we expect their decision in May to be almost entirely determined by whether or not a transitional deal has been fully agreed and signed by then”.
While there are signs of growth – for instance pay growth has accelerated a little and may overtake inflation this year. And exporters’ order books are benefiting from exchange rates with sterling. The services, factory and construction sectors all showed weaker-than-expected growth in January, according to surveys.
Grim growth forecasts
However, recent forecasts this week pointing to a weakening UK economy and grim scenarios for both a soft and hard Brexit may have the final say on any upward momentum on interest rates. Whatever growth we have seen in 2017 may soon be negated.
The forecasts, model the 15-year impact of the UK staying in the single market, doing a trade deal with the EU or leaving without a deal.
According to Government estimates, in each scenario, growth would be lower, by 2%, 5% and 8% respectively, than currently forecast over the 15-year period.
While Eurosceptics have dismissed these forecasts as nonsense, the forecasts are nevertheless concerning particularly as trade talks remain largely in deadlock.
Alan Clarke, an economist with Scotiabank, told Reuters that pay growth in the coming months could lead to a rate hike in May, but the BoE was unlikely to be explicit about this yet. “I think the message will be subtle and they will keep their options open,” he said.
Miles Eakers, Chief Market Analyst at Centtrip, agrees that a rate rise might come later in the year. “With inflation still high at 3%, today the Bank of England is likely to hint at further monetary policy tightening and an interest rate rise later in the year. This will boost the Pound, already up 3% against the US Dollar this year at $1.39."