Pound Rallies as BoE Hints at Rate Hike
The Bank of England has taken centre stage today with the circulation of the new £10 note featuring Jane Austen and news that an interest rate hike in autumn is possible.
In the morning, people have been queuing outside the Bank of England to get hold of the first £10 notes with Jane Austen, the “first” woman, other than the Queen, to feature on an English banknote. But, while this was a victory for women’s representation—despite a few complaints about an airbrushed version of Jane Austen’s face and a quote from one of her novels that doesn’t really work—all eyes were on the Bank of England and its decision on an interest rate hike, which was announced by midday.
While the Bank of England (BoE) voted to leave interest rates on hold today, at their current low of 0.25%, speculation that an interest rate hike in November is possible, has pushed the pound to a new-year high against the US Dollar.
The pound hasn’t reached $1.3337 since last September. It has now recovered half of its losses since the Brexit referendum in June 2016.
The BoE monetary policy committee voted to keep interest rates unchanged amidst risks to the UK economy due to the Brexit process, including slow wage growth and a squeeze on household spending. Only two of its nine members, Michael Saunders and Ian McCafferty, called for the interest rates to rise to 0.5% in order to keep inflation in control.
The committee’s minutes stated: “All MPC members continued to judge that, if the economy were to follow a path broadly consistent with the August Inflation Report central projection, then monetary policy could need to be tightened by a somewhat greater extent over the forecast period than current market expectations,” while adding that “some withdrawal of monetary stimulus was likely to be appropriate over the coming months.”
For the bankers, the UK economy looked stronger than expected: the GDP rose by 0.3% in the second quarter and unemployment rate continued to fall.
If inflation continues to rise and the economy performs well, then a rate rise will happen sooner than later. In the coming months, inflation is expected to rise as oil prices continue to rise, too. But as Brexit is progressing, the Monetary Policy Committee (MPC) said that cutting inflation, while supporting the job market and business activity would be a difficult task to balance: “During the negotiation period, those economic implications would be influenced significantly by the expectations of households, firms and financial markets. [The Bank must] take account of these evolving expectations in setting monetary policy insofar as they affected the outlook for activity and inflation.”
Some economists argued that the BoE’s indications for an interest rate hike were long overdue, while others predicted that with the economy struggling this autumn, there won’t be any changes in the interest rates in the near future.
At the moment, it appears that economists are split over the exact time of a possible interest rate hike, with some of them arguing that the pound has got overexcited, responding in an emotional manner. James Mackintosh of the Wall Street Journal tweeted: “What Bank of England says: ‘majority...if...gradual...some...likely...gradual...limited’. What GBP hears: ‘Rates UP UP UP UP, no question.’” Yael Selfin, chief economist at KPMG, also felt that some City experts were overly optimistic, highlighting that the very small wage growth and pressure on households, combined with a fall in their real earnings would demand that the BoE is very careful, especially with the ongoing Brexit negotiations.
Kathleen Brooks of City Index, said: “The Bank of England may have left rates on hold and the vote split may have stayed at 7-2, however, the tone of the statement was definitely more hawkish, and the prospect of a November rate hike is now a real possibility, in our view....We tend to assume that the BOE will make any major move at a meeting when the Governor presents the Inflation Report, which leaves November or February. Surely, if inflation is rising and the labour market continues to create jobs at its current clip then November could be key?”
In a similar tone was Capital Economics’ Paul Hollingsworth’s prediction: The minutes struck a considerably more hawkish tone than in August in suggesting that ‘some withdrawal of monetary stimulus is likely to be appropriate over the coming months.’ Indeed, this supports our long-held view that market expectations had gone way too far in expecting rates to remain on hold until 2019. If the economy continues to hold up, and there are clearer signs that wage growth is building, then the first hike could come somewhat earlier than we had previously envisaged, possibly as soon as the next meeting in November alongside the Inflation Report.”
Andrew Sentance, senior economic adviser at PwC, argued that the Bank was endangering the economy by delaying an interest rate hike: “The challenge facing the MPC is to deliver a gradual increase in interest rates which can be absorbed by the economy. By continually delaying the first move in this direction, there is an increasing risk that when interest rates do start to rise, it will take consumers and borrowers by surprise - and therefore create a bigger shock to the economy than it needs to be.”
While these economists argued for an interest rate hike, Dean Turner at UBS Wealth Management, thinks that there won’t be an interest rate hike anytime soon, because of a slowing down of the economy: “growth is likely to disappoint in the months ahead... [and] the track ahead presents obstacles on the political front. Theresa May is likely to reinforce her Brexit credentials in her speech next Friday and at the Conservative Party Conference, so let’s not get too carried away with the current rally.”
The Bank’s talk did its job
The most possible future outcome is that interest rates will remain as they are. The Bank of England managed to push the pound higher without raising interest rates, just by talking, a tactic that is common these days. Perhaps, as Rabobank says, by next summer an interest rate hike might happen, but at the moment, it seems impossible because the MPC is “dominated by doves” like Mark Carney, who are concerned about the effect of higher interest rates on real wages which depend on consumer spending.