The Bank of England said on Thursday that it may need to raise interest rates before the late 2019 date markets had been expecting, as it saw inflation rising and the economy growing steadily over the next few years.
With only a month until a national election, the BoE said the short-term squeeze on households from inflation since June’s Brexit vote would be more severe than it predicted in February, with price growth peaking at more than 2.8 per cent late this year.
Britain’s economy shrugged off expectations of a recession after last year’s referendum, and chalked up one of the fastest growth rates among major rich economies.
But as official data has soured since the start of the year, many economists expect tougher times ahead as Prime Minister Theresa May starts two years of fraught Brexit talks before the country leaves the European Union at the end of March 2019.
However, the BoE said it expected a pick-up in foreign trade and investment would offset a shortfall in domestic demand this year, and then sees a sharp pick-up in hitherto lackluster wage growth as unemployment fell to its lowest in a generation.
“Monetary policy could need to be tightened by a somewhat greater extent over the forecast period than the very gently rising path implied by the market yield curve underlying the May projections,” the BoE said on Thursday.
This could imply the BoE will raise rates for the first time since 2007 just as Britain leaves the EU.
The financial market instruments which the Bank of England uses to construct its economic forecasts fully priced in an interest rate rise only in the final three months of 2019, nine months later than in the last set of forecasts in February.
These market assumptions were based on average prices in the two weeks to May 3rd. Since then, markets have moved to price an earlier rate hike by the Bank of England and sterling has strengthened, which should help to push down on inflation.
The BoE said its latest forecasts assumed “that the adjustment to the United Kingdom’s new relationship with the European Union is smooth”.
‘Twists and turns’
In February BoE governor Mark Carney warned of "twists and turns" on the road to Brexit.
The BoE's Monetary Policy Committee (MPC) voted 7-1 in favour of keeping interest rates on hold at their record low 0.25 per cent this month, as expected in a Reuters poll of economists.
American academic Kristin Forbes, who leaves the MPC at the end of June, again voted to raise rates to 0.5 per cent and warned that the overshoot in inflation could become more protracted without tightening policy now.
Echoing language from the last policy meeting in March, the BoE said it would not take much upside news on growth and inflation for some other members of the MPC to join Forbes.
The central bank trimmed its forecast of growth this year to 1.9 per cent from 2.0 per cent, but nudged up its forecasts for 2018 and 2019 to 1.7 per cent and 1.8 per cent. Last year Britain’s economy grew 1.8 per cent.
The steady outlook for growth contrasts with a sharp slowdown in the official measure of growth seen at the start of this year, when the economy expanded just 0.3 per cent on the quarter – less than half its rate at the end of last year.
Weaker than estimated
The BoE said it expected first quarter growth to be revised up to 0.4 per cent, a rate it also forecasts for the current quarter. But earlier on Thursday, Britain’s Office for National Statistics said first-quarter growth in industrial production was weaker than it had previously estimated.
The BoE said inflation was likely to fall back to 2.16 per cent in just over two years’ time – still above the BoE’s target – and then pick up slightly going into 2020.
Usually Bank of England inflation forecasts show inflation falling steadily back to target.
Separately, British business groups reacted critically to elements of the leaked Labour Party manifesto.
Adam Marshall, director general of the British Chambers of Commerce, said that a plan to raise corporation tax to 26 per cent would “alarm” business unless it was linked to a cut in other levies.
“We need to send a message that the country is open for business after Brexit, a big increase in a profit tax does not send that message,” he said.
Josh Hardie, deputy director-general of the CBI, sharply criticised the leaked document on Thursday, saying: “If accurate, this is a manifesto that is past its sell by date.
"A number of these policies risk putting our economy into reverse gear rather than moving forward to support business in creating an inclusive, innovative economy that works for people in all corners of the UK," he added. – (Reuters/FT)
