Rate hike concerns weigh on U.K. stocks
The Bank of England lifted its forecasts for economic growth and suggested it may need to raise interest rates faster than previously indicated.
The Monetary Policy Committee, led by Governor Mark Carney, sees the U.K. growing quicker than its sustainable pace through 2020, meaning there’s a greater risk of overheating. Inflation is projected to remain above the 2 percent target under the current yield curve, which prices in about three quarter-point hikes over the next three years.
The MPC agreed that “monetary policy would need to be tightened somewhat earlier and by a somewhat greater degree over the forecast period than anticipated at the time of the November report,” according to the minutes of its latest meeting published on Thursday.
The pound jumped after the announcement and was up 0.8 per cent to $1.3995 as of 12:03 p.m. London time.
The comments may fan market expectations of a rate hike as soon as May. Bets on such a move increased in the run up to the February decision and a number of economists also now see an increase in the first half of the year.
The new outlook from the BOE came as it left the benchmark interest rate unchanged at 0.5 per cent. The vote was unanimous, though there was speculation that one or two of the nine policy makers would vote for a hike.
In its updated forecasts, the BOE sees growth at 1.8 per cent this year and next, up from its November projections. While consumption will remain weak and Brexit is damping investment, global demand is helping U.K. trade, it said.
Policy makers also reiterated that a range of Brexit outcomes are still possible. Those developments “remain the most significant influence on, and source of uncertainty about, the economic outlook,” they said in the Inflation Report.
The central bank cut its estimate of the equilibrium unemployment rate, or the lowest level of joblessness that won’t trigger quicker wage gains, to about 4.25 per cent from 4.5 per cent. The current rate is 4.3 per cent.
It warned there’s little spare capacity left to burn, and the economy’s speed limit, or the rate it can expand without fanning inflation, has dropped to about 1.5 per cent since the Brexit vote.
Because of that, all the slack left in the economy will be eroded within two years and excess demand will then start to build.
Since the vote to leave the European Union in June 2016, the BOE has said it could tolerate faster inflation driven by the weaker pound to support growth. While it had previously stretched its horizon, seeking to return inflation to target over three years, the stronger growth projection means they are now aiming to get inflation to the goal in two years.
In a letter to Chancellor of the Exchequer Philip Hammond explaining why the inflation rate had deviated from target, Carney wrote “the prospect of a greater degree of excess demand” had “further diminished the tradeoff” that policy makers could accept.
The economy’s scope to comfortably expand has been curtailed because of weak productivity over the past decade. Brexit has added an additional pressure by suppressing investment.
The bank sees inflation at 2.2 per cent in the first quarter of 2020 -- above the 2 per cent goal -- further indicating it will need to tighten policy faster.
--With assistance from Harumi Ichikura Zoe Schneeweiss Paul Gordon and Andrew Atkinson