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Bank of England Hikes Key Interest Rate to 0.5 percent

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Written By: Adrian Moore – Forex Focus

The pound sterling slides on dovish statements from policymakers as focus shifts to Brexit talks.

The Monetary Policy Committee (MPC) of the Bank of England voted by a 7-2 majority to raise key interest rates from 0.25 to 0.50 percent, following the penultimate MPC meeting of the year. The committee members also voted unanimously to maintain the current asset-purchase program, which includes purchasing UK government bonds at £435 billion and non-financial investment-grade corporate bonds at £10 billion per month respectively.

The monetary policy meeting held on October 31–November 1 created a record of sorts, as the benchmark bank rate rose for the first time in more than a decade. The last time the United Kingdom’s central bank increased bank rates was in July 2007, when it hiked interest rates from 5.50 to 5.75 percent. The 2008 financial crisis saw interest rates in the UK fall to historical lows of 0.50 percent in March 2009, as the central bank went all out to help the UK economy recover from the global liquidity crunch.

Source: Bank of England website

According to the minutes of the meeting, a 25-basis point increase in the bank rate was fully factored in by the markets in the run-up to November’s MPC meeting, and the interest-rate curve underlying the November Inflation Report projected interest rates at 1 percent by the end of the three-year forecast period, higher than the recent median estimates of economists polled by Reuters.

The recently announced preliminary third-quarter GDP (gross domestic product) numbers from the Office for National Statistics (ONS) showed that the UK economy expanded at 0.4 percent, modestly higher than the 0.3 percent in the second quarter and more than estimated by the central bank staff. GDP growth was backed by a rebound in the manufacturing sector, with stable growth in the services sector, while output in the construction industry dropped for the second straight quarter. Growth in household consumption was subdued with business investment and net trade contributing to the annual GDP numbers, in line with the MPC’s November Inflation Report.

Recent trade data from the ONS pointed to a slightly depressing net-trade number in the third quarter, although surveys for export orders remained robust. Consumption indicators over the last few months were mixed with retail sales volumes rising in the third quarter, in spite of declining in September, while seasonally adjusted consumer confidence measured by the GfK/EC survey rose modestly in October. Likewise, house-price inflation amplified more than estimated in the August Inflation Report during the third quarter, while the RICS survey of real-estate agents pointed to a fall in prices over the next three months.

Policymakers expect consumer inflation to continue expanding following a 3-percent rise in September, as a depreciated pound sterling and a recent rise in global energy prices are passed on to consumers. In addition, domestic inflationary pressures are expected to kick in as inventories are absorbed and wage growth rebounds in the near- to medium-term. The committee, however, anticipates inflation to normalise and approach the bank’s 2-percent target by the end of the forecast period.

The MPC of the Bank of England concluded that its projections are based on the median outcome of its trading relations with the European Union (EU) going forward. However, in the interim period, the decisions of households and businesses are based on a smooth transition following Britain’s exit from the EU in March 2019. Although business investments are growing at a modest pace, they continue to be affected by uncertainties surrounding the impact of the Brexit talks. According to the minutes, although monetary policy cannot prevent the outcome of international trading arrangements, in the event of exceptional circumstances, the committee stands prepared to balance inflation with economic activity and job creation through a supportive policy.

Economic growth in the UK was broadly supported by consumer confidence and exports reinforced by a weaker pound sterling, with the easing of credit conditions leading to credit growth, loose fiscal policy and global economic growth. While the positives include the unemployment rate falling to 42-year lows, a weaker pound sterling is leading to a spike in consumer inflation; in the event of a negative outcome in the negotiations with the European Union, the UK currency could slide further, leading to a rise in consumer prices and leaving the Bank of England in a very precarious situation in which easing interest rates will be ruled out due to high inflation, and hiking rates will lead to a slowdown in economic activity. In a televised interview on November 6, BoE Governor Mark Carney warned that a bad Brexit deal will lead to inflationary pressures in the UK, and the bank may not be able to cut interest rates, even in the event of growth slowing down.

The pound sterling slipped against the euro and the greenback following the interest-rate decision, which analysts considered a one-off move, with a few of them even suggesting that the interest-rate hike was a policy mistake. Although Deputy Governor Ben Broadbent went on the offensive to state that more rate hikes were necessary to rein in inflation, analysts remain sceptical that the central bank would do anything more to alter the current monetary policy until more clarity on the Brexit discussions emerge.

The pound sterling settled lower at 1.3074 versus the US dollar at the end of the first week of November, extending its decline for the third successive week. The pair ended 0.4 percent lower for the week and was seen holding on to key technical supports at 1.3050. Versus the single European currency, the pound sterling settled at 1.1260, down by 0.39 percent for the week.

The Monetary Policy Committee of the Bank of England next meets on December 12-13, 2017, for the last time this year.


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