A rise in rates once meant that the economy was returning to normal health, but not this timeby Duncan Weldon / October 26, 2017 / Leave a comment
Rarely has an interest rate rise in the UK been as well flagged as the one expected next week. Over the past few months, Bank of England reports, speeches from Monetary Policy Members and interviews from the Governor have all played up the fact that rates will rise “soon.” Next Thursday the crescendo will end either with the first hike in more than a decade or with Mark Carney cementing his reputation as an “unreliable boyfriend” who can’t be trusted on the path of rates. With the markets pricing in around an 85 per cent chance of a hike and with so much credibility staked on the decision, it is hard to see the Bank backing down now.
Of course, although journalistic convention demands that any increase in the Bank’s base rate is called a “hike,” it’s important to remember that what the Bank will likely do next week is take the level of rates from the historically low 0.25 per cent they reached last August back to the still historically low level of 0.5 per cent which prevailed for the eight years before. UK monetary policy is still set to be ultra-easy next week, just a little less easy than it was.
Although inflation is high and unemployment low, growth is fairly tepid, real incomes are being squeezed and Brexit-related uncertainty is putting a dampener on business investment decisions. Now hardly seems like an ideal time to start tightening policy. Indeed, until only a few months ago financial markets expected no increase from the Bank before 2019. This raises two questions—what changed? And is this just a lone hike or the start of a cycle? The answers look to be related.
To answer both, the important point to grasp is that the Bank is not being driven into hiking by a renewed sense of confidence in the UK economic outlook. Indeed its most recent forecasts show growth plodding along around the 1.6 to 1.7 per cent mark for the next two years against a pre-crisis average of almost 3 per cent. If anything the Bank has become more pessimistic on the medium term outlook at the same time as loudly signalling that it feels the need to tighten policy.
“The Bank is not being driven into hiking by a…