Mark Carney has signalled that it is time for an interest rate rise. What’s his thinking?by George Magnus / February 12, 2018 / Leave a comment
Following in the footsteps of the United States Federal Reserve and the Bank of Canada, the Bank of England now looks set to join the “hikers.” A couple of increases in interest rates this year, at least, may kick off in the spring. What’s the thinking here? The key issue is the economy’s supply side.
The Bank has revised up its expectation of GDP growth this year by 0.1 per cent to 1.8 per cent, and is comforted by the buoyancy of the global economy. But it is disappointing that UK economic growth isn’t matching the upward adjustments to growth in the US, the European Union and emerging markets. As the bulk of independent forecasters have noted for some time, this can be attributed to the related combination of a weak investment cycle, persistent Brexit uncertainty, and higher inflation. Inflation looks likely to continue to exceed the Bank’s 2 per cent target over the next three years.
The Bank can’t do anything about investment and Brexit, but inflation most certainly lies within its remit. Although it thinks the post-Brexit fall in sterling, as a cause of higher prices, is pretty much over now it is not happy that inflation will remain above target. While it was previously prepared to tolerate higher inflation to support employment growth and economic activity, it now judges that both have reached the point where the trade-off with interest rate inactivity is no longer justified. The Bank’s Governor, Mark Carney, confirmed after the release of the quarterly Inflation Report last week that increases in interest rates were likely earlier and faster than previously expected.
Putting all this another way, the good news is that the economy looks reasonably stable now, notwithstanding Brexit, and has achieved the lowest level of unemployment for 42 years. The Bank thinks that the growth in wages and salaries is now starting to rise slowly, and will reach around 3 per cent. As it does so, the previously negative gap with regard to inflation will close, and pay could edge above inflation.
The bad news is that the Bank thinks there is very little slack in the economy, perhaps no more than 0.25 per cent of GDP. The Bank’s economists think that while there may be more slack in the…