UK financial markets not expected to increase

Financial markets are not expecting any increase in UK rates in the coming 12 months despite a pick-up in inflation to 2.9%.

However, recent signals from the Bank of England suggest that a rate hike could materialise during the second half of this year.

The June meeting of the Bank of England’s Monetary Policy Committee (MPC) concluded with no changes to policy. This was in line with market expectations.

However, there was surprise that three of the eight members of the MPC voted to raise the key bank rate from 0.25% to 0.5%. The expectation had been that there would be only one vote for a rate hike.

The meeting minutes outlined the policy deliberations that took place, with the discussion centred on the outlook for inflation.

The MPC acknowledged that CPI inflation had risen further above target to 2.9%, which was higher than its own expectations. The MPC also commented that measures of core inflation had also been higher than expected.

The worsening inflation backdrop, combined with the recent fall in sterling, saw the MPC observe that the overshoot of inflation — relative to the target — might be somewhat greater than previously supposed, while the extent of spare capacity in the UK economy also appeared to be limited.

As a result, arguments were put forward at the meeting in favour of a moderate tightening in policy.

In this context, along with referencing the fact that slack in the labour market appeared to have diminished, it was noted that the withdrawal of part of the monetary stimulus injected back in August 2016 in the aftermath of the Brexit referendum vote, would help to moderate the inflation overshoot.

However, given the marked slowdown in growth in the opening quarter of this year, the majority on the MPC felt that it would be appropriate to keep rates unchanged for now, as it was too early to judge with confidence how large and persistent the slowdown in activity would prove to be.

Two key MPC members who voted to keep rates on hold; the Bank’s governor, Mark Carney and chief economist Andy Haldane, have hinted that they might support a rate hike later this year, depending on how the economy performs. Governor Carney said “now is not yet the time” to begin raising rates.

Instead, he would prefer to wait and see how the economy performs over the coming months and reacts to the “reality of Brexit negotiations”.

Andy Haldane also indicated that this is not the time to be in a rush to tighten monetary policy given that there is a chance of a sharper-than-expected slowdown in economic activity.

However, he added that should the UK economy show solid growth, then he believed withdrawing some of the additional stimulus provided in August 2016 would be prudent during the second half of this year.

Economic data in the months ahead, then, are likely to be crucial in terms of whether or not we get a rate hike. The caution of senior Bank of England officials about growth would seem warranted.

High inflation is likely to continue to restrain the pace of economic growth in the second half of the year.

It would also seem prudent to wait to see if the negotiations on Brexit, the lack of clarity on what form Brexit will take and the political uncertainty in the UK in the aftermath of the general election also weigh on economic activity, especially investment.

It is not that surprising, then, that markets remain doubtful that UK rates will rise anytime soon, despite the shift in MPC thinking in this direction.

Even if there is a rate rise, it is likely to prove a one-off hike as the Bank simply unwinds last year’s rate cut.

Oliver Mangan is chief economist with AIB.


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