Money For Lunch – Central Bank Activity Tightens

Central Bank Activity Tightens

November 9, 2017 9:27 AM0 commentsViews: 8

 

On Thursday, 2 November 2017 the Bank of England Monetary Policy Committee announced an interest rate hike of 25-basis points. Now, the UK bank rate is 0.50%. This is the first rate hike since 2007, and marks a dramatic reversal in BOE policy. Bank of England governor Mark Carney surprised markets somewhat by adopting a hawkish stance and raising interest rates at the November meeting. In fact, the BOE target of 2% inflation has largely been overshot by current inflation trends in the UK (hovering around 3%) while real wage growth has been lagging at just 2.1% or 2.2%.

The MPC (Monetary Policy Committee) voted by margin of 7-2 to tighten monetary policy. Given the constraints of the Brexit-related pressures following the June 23, 2016 referendum the BOE has been tasked with ushering the UK economy through a dire predicament. In September 2017, the Bank of England Monetary Policy Committee prepared markets for the prospect of a rate hike. The disinvestment in the UK economy owing to multinational corporations seeking alternative European capitals for their headquarters, has seen capital flight from the UK.

BOE Targets 2% Inflation

September’s inflation shock of 3% was notable, and it prompted the BOE to act. Domestic activity – production and employment – have fallen, owing to Brexit uncertainty. Fortunately, the macroeconomic forecast by the Bank of England indicates that the UK will likely endure a smooth adjustment through the Brexit process, much in line with the August inflation report. However, Brexit pressures notwithstanding the BOE anticipates a slight tempering of expectations from 1.7% GDP growth to 1.6% GDP growth this year. Clearly, the UK decision to ‘divorce’ from the EU is having an impact on overall economic activity.

The UK has considered its alternatives with respect to trade agreements with the rest the world. Currently, there are some 24 nations that the UK has WTO (World Trade Organization) agreements with. The UK could theoretically continue trading with EU nations according to WTO guidelines and frameworks, however it can also negotiate individual trade deals with member countries. For 2018, the Bank of England anticipates GDP (gross domestic product) growth of 1.6%, and that figure increases to 1.7% in 2019.

Higher Interest Rates Provide Cushioning in the Event of an Economic Downturn

However, not everybody is sold on the prosperity of the UK economy over the short-term. Wilkins Finance expert Charles S. Bellwether believes that inflation will continue to rear its ugly head in Q3 and Q4 2017. When the actual figures are reported, he anticipates at least 3% owing to the sharp depreciation of the GBP over the year. For BOE analysts, it appears that the inflation objective of 2% will be reached by 2020. Over the next 2-3 years, currency traders, investors and analysts are not expecting too much movement in bank rate tightening. Modest increases are likely, given the pressures currently in the UK economy.

With household debt at relatively high levels, sharp increases in interest rates are likely to add additional pressure on the average UK household. If present indications are anything to go by, just 2 rate hikes of 25-basis points each are likely by 2020. Interest rate hikes are good news in that they serve as bargaining chips if the economy turns bad. The BOE will be able to use the ‘increased cushion’ of higher interest rates to adopt quantitative easing if the Brexit process proves difficult.

 

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