02 Nov

UK raises rate 25 bps, ready to respond to any changes

November 2, 2017

By CentralBankNews.info
      The Bank of England (BOE) raised its benchmark Bank Rate by 25 basis points to 0.50 percent to curb inflation but said there were considerable risks to its economic outlook in connection with the U.K.’s withdrawal from the European Union (EU) and it “stands ready to respond to changes in the economic outlook as they unfold to ensure a sustainable return of inflation to the 2% percent target.”
      Today’s rate hike is the BOE’s first change in rates since August 2016 when it cut the rate by 25 basis points to a record low in the wake of the election to leave the EU, known as Brexit.
      But the BOE still appears far from embarking on a monetary tightening cycle, like the U.S. Federal Reserve and the Bank of Canada, and its Bank Rate is now only back to the level that prevailed from March 2009, when major central banks worldwide slashed rates in response to the global financial crises.
      The BOE’s neutral guidance over its next policy move reflects its deep concern over how Brexit negotiations are weighing on domestic activity, which it said had slowed even as global growth had risen significantly.
      “The decision to leave the European Union is having a noticeable impact on the economic outlook,” the BOE said, with Brexit-related constraints on investment and labour supply further pushing down the rate at which the economy can grow without generating inflation pressures.
      While the BOE’s Monetary Policy Committee (MPC) voted by 7-2 for the rate cut, all members were in favor of maintaining the current stock of assets that have been purchased as part of a monetary policy measure known as quantitative easing.
      As expected, MPC members Jon Cunliffe and Davee Ramsden voted to maintain the rate.
      In addition to last August’s rate cut, the BOE also launched a package of stimulus measures that included the purchase of 10 billion pounds of corporate bonds and expanded its purchase of government bonds by 60 billion pounds to a total of 435 billion to cushion the economy from the uncertainty that will accompany the country’s adjustment to life outside the EU bloc.
       Today’s rate hike was widely expected by financial markets and investors, and follows the BOE’s guidance in September that a withdrawal of some stimulus was likely to be appropriate in coming months to return inflation to target.
       But the BOE’s rather gloomy outlook clearly took investors by surprise, with pound sterling taking an immediate hit while UK stocks rose on the belief that the BOE will continue with an accommodative policy stance.
       Since the June 2016 vote on leaving the EU, the pound has fallen sharply, with the result that import prices and thus inflation has been pushed up.
         The rate hike is a direct response to the rise in inflation from the fall in the pound and the BOE said it expects inflation to peak above 3 percent in October as past depreciation and recent rises in energy prices continue to be passed onto consumer prices.
        But while the impact of higher import prices on inflation will slowly taper, the upward pressure on inflation will continue as spare capacity in the UK economy is absorbed and wages rise.
        On balance, inflation is expected to ease over the next year and then approach the 2 percent target by the end of the forecast period, BOE said.
        In its latest inflation report, the BOE estimated the UK economy can only grow around 1.5 percent a year before it leads to inflation, sharply down from 2.7 percent before the global financial crises, as productivity has hardly risen over the past decade.
        The UK economy is seen expanding by an average of 1.6 percent this year, down from the August forecast of 1.7 percent, and by 1.6 percent in 2018, unchanged from August.
       “Consumption growth remains sluggish in the near term before rising, in line with household incomes,” BOE said.
       In the third quarter of this year the UK economy grew by an unchanged rate of 1.5 percent.
       In 2019 and 2020 growth is seen rising slightly to 1.7 percent each year, the same as in August.
       Inflation is expected to remain above the BOE’s target, hitting 3.0 percent in the fourth quarter of this year, up from the August forecast of 2.8 percent, before easing to 2.4 percent in Q4 2018, down from 2.5 percent previously forecast.
         In 2019 inflation is seen easing further to 2.2 percent and then to 2.1 percent by the fourth quarter of 2020.
         Inflation in the U.K. has been accelerating all year and has been above the BOE’s 2.0 percent target since February.
      In September the headline inflation rate hit a 2017-high of 3.0 percent, up from 2.9 percent in August, and the highest rate since April 2012.
      Even the core inflation rate, which excludes energy, food, alcohol and tobacco, was at 2.7 percent in September, unchanged from August but also a 2017-high.
      Pound sterling fell to 1.31 to the U.S. dollar after the rate hike from close to 1.328 and is almost 10 percent lower than before the June 2016 vote to leave the EU.

      The Bank of England issued the following statement:

“The Bank of England’s Monetary Policy Committee (MPC) sets monetary policy to meet the 2% inflation target, and in a way that helps to sustain growth and employment.  At its meeting ending on 1 November 2017, the MPC voted by a majority of 7-2 to increase Bank Rate by 0.25 percentage points, to 0.5%.  The Committee voted unanimously to maintain the stock of sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, at £10 billion.  The Committee also voted unanimously to maintain the stock of UK government bond purchases, financed by the issuance of central bank reserves, at £435 billion.
The MPC’s outlook for inflation and activity in the November Inflation Report is broadly similar to its projections in August.  In the MPC’s central forecast, conditioned on the gently rising path of Bank Rate implied by current market yields, GDP grows modestly over the next few years at a pace just above its reduced rate of potential.  Consumption growth remains sluggish in the near term before rising, in line with household incomes.  Net trade is bolstered by the strong global expansion and the past depreciation of sterling.  Business investment is being affected by uncertainties around Brexit, but it continues to grow at a moderate pace, supported by strong global demand, high rates of profitability, the low cost of capital and limited spare capacity. 
CPI inflation rose to 3.0% in September.  The MPC still expects inflation to peak above 3.0% in October, as the past depreciation of sterling and recent increases in energy prices continue to pass through to consumer prices.  The effects of rising import prices on inflation diminish over the next few years, and domestic inflationary pressures gradually pick up as spare capacity is absorbed and wage growth recovers.  On balance, inflation is expected to fall back over the next year and, conditioned on the gently rising path of Bank Rate implied by current market yields, to approach the 2% target by the end of the forecast period.  
As in previous Reports, the MPC’s projections are conditioned on the average of a range of possible outcomes for the United Kingdom’s eventual trading relationship with the European Union.  The projections also assume that, in the interim, households and companies base their decisions on the expectation of a smooth adjustment to that new trading relationship.
The decision to leave the European Union is having a noticeable impact on the economic outlook.  The overshoot of inflation throughout the forecast predominantly reflects the effects on import prices of the referendum-related fall in sterling.  Uncertainties associated with Brexit are weighing on domestic activity, which has slowed even as global growth has risen significantly.  And Brexit-related constraints on investment and labour supply appear to be reinforcing the marked slowdown that has been increasingly evident in recent years in the rate at which the economy can grow without generating inflationary pressures. 
Monetary policy cannot prevent either the necessary real adjustment as the United Kingdom moves towards its new international trading arrangements or the weaker real income growth that is likely to accompany that adjustment over the next few years.  It can, however, support the economy during the adjustment process.  The MPC’s remit specifies that, in such exceptional circumstances, the Committee must balance any trade-off between the speed at which it intends to return inflation sustainably to the target and the support that monetary policy provides to jobs and activity.  
The steady erosion of slack has reduced the degree to which it is appropriate for the MPC to accommodate an extended period of inflation above the target.  Unemployment has fallen to a 42-year low and the MPC judges that the level of remaining slack is limited.  The global economy is growing strongly, domestic financial conditions are highly accommodative and consumer confidence has remained resilient.  In line with the framework set out at the time of the referendum, the MPC now judges it appropriate to tighten modestly the stance of monetary policy in order to return inflation sustainably to the target.  Accordingly, the Committee voted by 7-2 to raise Bank Rate by 0.25 percentage points, to 0.5%.  Monetary policy continues to provide significant support to jobs and activity in the current exceptional circumstances.  All members agree that any future increases in Bank Rate would be expected to be at a gradual pace and to a limited extent.
There remain considerable risks to the outlook, which include the response of households, businesses and financial markets to developments related to the process of EU withdrawal.  The MPC will respond to developments as they occur insofar as they affect the behaviour of households and businesses, and the outlook for inflation.  The Committee will monitor closely the incoming evidence on these and other developments, including the impact of today’s increase in Bank Rate, and stands ready to respond to changes in the economic outlook as they unfold to ensure a sustainable return of inflation to the 2% target.”

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