The Bank of England pushed interest rates above their financial crisis lows on Thursday, but signalled it was in no hurry to raise them further as Britain heads for Brexit next year with no clear plan for leaving the European Union.
The BoE’s nine rate-setters unexpectedly voted unanimously to raise rates to 0.75 from 0.50 per cent, the level at which they have spent most of the past decade, apart from a period after the 2016 Brexit vote when they were cut even lower.
But sterling fell against the dollar and the euro and British government bond prices rose after BoE Governor Mark Carney stressed the gradual path for rate hikes ahead.
“Policy needs to walk – not run – to stand still,” he said as he explained a new BoE estimate of neutral interest rates for Britain’s economy, which the central bank believes will gradually rise against a backdrop of strong global growth.
Carney later told the BBC that one rate rise a year for the next few years was a good rule of thumb for the public, as long as there is no major Brexit shock for the economy.
Growth in Britain, the world’s fifth-biggest economy, has slowed since the referendum decision in 2016 to leave the EU.
But the BoE pushed ahead with its rate hike because it believes the economy is operating almost at its “speed limit,” or full capacity, raising the prospect of more home-grown inflation pressure ahead.
The increase in borrowing costs looks minimal compared with the average 5 per cent rate before the financial crisis.
But business groups criticised the decision, which comes when there is so little clarity on Brexit. The British Chambers of Commerce called it ill-judged and the Institute of Directors said the BoE had “jumped the gun.”
With less than eight months to go, London and Brussels – as well as key members of the government – remain far apart about the future Britain-EU trading relationship.
Carney played down fears the BoE would be forced into a U-turn on rates, saying the central bank was sticking to its assumption that there would be a smooth Brexit transition.
“The mistake is to always wait, wait, wait until you have perfect certainty,” he said.
The BoE’s backed up its message of gradual and limited rate increases with its forecasts for inflation only a fraction above its 2 per cent target over the next few years.
The central bank said inflation in two years’ time was most likely to be 2.09 per cent.
The forecasts were based on bets by investors who expect another rate hike only in late 2019 or early 2020, with Bank Rate creeping up to 1.1 per cent in late 2020. That is a fraction lower than a projection of rates of 1.2 per cent the last time the BoE published forecasts for the economy in May.
“No one should get too excited about this being a sign of things to come,” said Luke Bartholomew, an investment strategist at Aberdeen Standard Investments.
“It is almost unthinkable that the Bank of England will follow up with further rate rises in the next few months given the risks on the horizon.”
However, markets now price in a greater than 50 per cent chance that the BoE will raise rates again by May next year, shortly after Britain is due to leave the EU.
The BoE forecast that Britain’s economy would grow by 1.4 per cent this year, unchanged from its view in May, but it nudged up its 2019 forecast to 1.8 per cent from 1.7 per cent.
Wages were likely to be growing by an annual 2.5 per cent at the end of this year, a bit slower than it thought in May, before rising to 3.25 per cent by late 2019.
U-turn risk
Several analysts challenge the BoE’s view that inflation pressures are building and say raising rates now only risks a U-turn by the central bank if Britain fails to get a Brexit deal.
Carney reiterated there could be “consequences for monetary policy” if Brexit led to a shock for Britain’s economy.
Some investors think the risk of a global trade war is another reason for caution.
The BoE said it saw “tentative signs that actual and prospective protectionist policies were starting to have an adverse impact” on global trade.
It also fleshed out its thinking on how far it is likely to go with its planned rate hikes by publishing a new long-term forecast for what it called Britain’s trend real interest rate, or “R*”, of zero to 1 per cent, more than 2 per centage points below its pre-financial crisis level.
Adjusted for the BoE’s inflation target, this would imply Bank Rate of 2 to 3 per cent to keep growth and inflation rates stable when the economy is running at full capacity.
In the shorter term, the Bank Rate implied by a so-called equilibrium real interest rate, or “r*”, was likely to be somewhat lower, the BoE said, without giving a precise estimate.
Carney said the estimates should not be considered as a target for BoE policy but added r* was likely to rise slowly.