Bank of England keeps all options open on interest rates

Investors hoping for a hawkish or a dovish steer from the Bank of England’s May Inflation Report will be disheartened: the message following the decision to leave interest rates unchanged is essentially to wait and see. Because inflation has fallen faster than the BoE expected when it last published forecasts in February.

The Monetary Policy Committee feels it has more time to examine the evidence before acting. Policymakers think the effects of sterling’s Brexit-related depreciation are likely to fade a little faster than thought, so they now project that inflation will return to the 2 percent target in two years, even if the next rate rise is delayed.

Three quarter-point increases by 2021, the forecasts imply, would stabilise the economy and inflation. This is roughly the extent of tightening that was priced into markets in the run-up to this decision - and before the February Inflation Report.

So while it has cut the estimate for annual growth in the second quarter of 2018, from 1.8 percent in the February projections to 1.4 percent in the May report, this is almost entirely down to the output that has already been lost. Although the report admits to “considerable uncertainty about momentum in the first half of the year”, it puts the annual growth rate in the second quarter of the following three years at an unchanged 1.7 percent. Underlying situation is unchanged The BoE’s judgement of the underlying position is essentially unchanged. It thinks there is little slack left in the economy, with unemployment close to its equilibrium rate and wage growth picking up.

And it believes that while demand growth will be modest by historical standards, supply growth will be even weaker - curbing the rate at which the economy can expand without stoking inflation. Supply growth will be held back by lower net migration - in particular, migration from the EU, which is disproportionally work-related.

And while the UK’s low rate of productivity growth may improve, it will be held back by businesses’ reluctance to invest — even in such a favourable environment for exporters — while the uneasiness over post-Brexit trade arrangements persists.

In sum, the bank may well not hike this time around. But it will probably signal that August is becoming a definite candidate for an increase. This sense of having to move soon will be heightened by the October European Union (EU) summit. Previous summits saw negotiations between the UK and EU become increasingly fractious, even if solutions were found in the end. Thus, Carney may feel that August is his last chance before Brexit takes centre stage once again.



Written by Scherzando Karasu, External Financial Journalist

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