A 'smooth' Brexit would lead to interest rate rises, says the Bank of England
At the 10 May 2017 meeting of the Bank of England's Monetary Policy Committee (MPC), the Committee voted 7-1 to maintain Bank Rate at 0.25%. The committee also voted unanimously to maintain its quantitative easing (QE) programme, with the purchase of £10 billion non-financial investment grade corporate bonds and the purchase of £435 billion UK government bonds. Of the 8 member committee, following Charlotte Hogg's departure, only one - Kristin Forbes - felt it appropriate to raise the Bank Rate by 0.25% to 0.50%. The remaining 7 committee members felt that an increase in Bank Rate to offset the effect of weaker sterling on inflation following the Brexit vote, would only lead to higher unemployment and potentially even weaker income growth.
The MPC closely considered a broad range of economic indicators when reaching this decision noting that "the appropriate path for monetary policy depends on the evolution of demand, potential supply, the exchange rate, and therefore inflation." Reporting on the first quarter results, the Committee noted a slowdown in aggregate demand - partially explained due to the impact of the depreciation on sterling on household income and therefore spending - with the expectation now for quarterly growth to remain close to trend around current levels. Weaker consumption is therefore expected for 2017. Despite this, the Committee noted stronger economic data internationally with latest projections showing an increase in corporate investment growth during the year bolstered by a weaker sterling. Sterling remains 16% below a November 2016 peak, despite appreciating 2.5% between February and May 2017.
CPI Inflation breached the MPC's 2% target level as the weaker sterling fed through to consumer prices with the Committee expecting it to peak just below 3% by the fourth quarter of 2017. Wage growth was weaker than expected with a consequential squeeze expected for households during 2017.
The minutes note that the Committee's policies are predicated on a smooth adjustment to the new relationship between the UK and the EU following the triggering of Article 50 and that a tightening of monetary policy may be required should the economy follow a path aligned to the May central projections.
Commentary
Interest rates are set by the MPC who use their level to adjust monetary policy as and when required to keep inflation around a target level set at 2%. The vote for the UK to leave the EU had an immediate impact on the UK economy by depreciating the value of sterling. While this has had a positive effect in that a weaker sterling enhances the competitiveness of UK exports internationally, it also produces a counter-negative in rising prices domestically as import costs rise, which in turn tightens household incomes reducing household spending.
The record low interest rates in the UK have detracted from savers incomes since 2009, evoking what some have termed the "Savings Crisis" as those in retirement have failed to meet the returns required for retirement. Rising inflation provides hope for savers in that typically we would expect to see a rate rise. However, this would be conditional on the effect of a decline in sterling persisting coupled with an improvement to economic data.
Despite this, the MPC has noted that if the Bank's projections are accurate and the UK economy begins to improve, monetary policy may need to be tightened. This could see an interest rate rise sooner than the market is presently pricing in, albeit it is now expected that two rate rises will occur over the next three years. For a rate rise to occur though, the MPC needs the support of at least five MPC members and Kristin Forbes is due to step down from the Committee in June.
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