To hike or not to hike: What chance is there the Bank of England will raise interest rates at this month’s policy meeting?

Markets are pricing in very little chance of rates rising, although some of the economic indicators would support a hike. Nomura has argued there is actually a 60% chance of a hike (and detailed 20 reasons why the MPC should raise rates by 25 basis points) but the Bank is almost certain to keep the lid on any policy changes for now.

A 5-3 split at the last MPC meeting and some fairly hawkish comments from some policymakers suggested the Bank was leaning closer to hiking this year, in part to correct what many felt was a premature cut to rates last year in the wake of Brexit.

The internal dynamics of the MPC are different this time with the replacement of Kristin Forbes, the most hawkish member of the MPC, with Silvana Tenreyro. Her views are less well known but she could side with the hawks – for instance she has previously argued that lower interest rates don’t work during a recession, preferring higher fiscal spending.

Manufacturing growth is picking up, the labour market is tightening and the Bank is worried about spiralling consumer debt – all good reasons for a policy ‘correction’ to bring rates back to 0.5%. However on balance it looks like the Bank will hold. Here’s a few reasons why:

Inflation has cooled, removing any significant pressing need to raise rates. CPI inflation retreated to 2.6% in June from 2.9% in May. Core inflation, which strips out volatile food and energy prices, fell back to 2.4% from 2.6% in May. Global reflationary pressures may have eased, with inflation in the US and Europe failing to rise as quickly as expected. This is expected to keep monetary policy looser for longer and should act as a counter to any hawkish tendencies among MPC members. The yield on the two-year gilt is only just above 0.25%, having peaked around 0.36% in late June when talk of a an imminent hike was doing the rounds.

Of course inflation is above the target, and the Bank has only limited tolerance for continued above-target inflation. However, as previously detailed, most of the inflation comes from the change in the sterling exchange rate. Given the year-on-year pass-through of last June’s slide and the recent rally in the pound-dollar rate, it does appear that the worst of the decline in sterling on import prices has passed, justifying the MPC’s willingness to look through the data. The Bank will want to wait for more information over the coming months on inflation before acting.

The MPC may yet seek to push rates back up to 0.5% this year, if conditions in the wider economy improve whilst inflation remains above 2%. Slacker inflation is a good sign for aggregate demand so this may yet support conditions for a rate hike, but we know that Mark Carney for one wants to see improvements in business investment, which appears to be melting away as Brexit affects companies’ spending.

Wage growth is non-existent. Real earnings growth is still negative and although employment levels are at record highs, this has failed to feed through to higher earnings. This ought to keep the MPC fairly cautious and probably wait-and-see for more data on this front. Real earnings have fallen 0.7% in the last year.

Growth is ok but hardly spectacular and with risks tilted to the downside because of Brexit the risk is that a move to tighten policy could choke off what growth there still is. Political uncertainty is significantly weighing on business investment and this poses a problem to any hike. It may be viewed as an unnecessary additional pressure.



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