Signaling that inflation is overtaking Brexit-related slowdown as an economic risk, Bank of England policy makers said they’re headed toward raising interest rates for the first time in more than a decade.
The pound surged and gilt yields jumped as investors anticipated rates may increase as soon as November, far earlier than the previous consensus. That came after the BOE revealed that for a majority of policy makers, “some withdrawal of monetary stimulus was likely to be appropriate over the coming months in order to return inflation sustainably to target.”
While officials noted that Brexit still poses a risk to the economy, they said that data since their last decision points to a “slightly stronger picture than anticipated.” There’s also been a renewed inflation pickup and the MPC said it’s seen signs of what could be a tentative recovery in pay growth. That’s a key metric for the bank, and its absence has been cited as signaling that domestic price pressures are under control.
“The minutes struck a considerably more hawkish tone,” said Paul Hollingsworth, an economist at Capital Economics. “If the economy continues to hold up, and there are clearer signs that wage growth is building, then the first hike could come somewhat earlier than we had previously envisaged.”
The statement came alongside the latest policy decision, which saw the committee, led by Governor Mark Carney, vote 7-2 to hold the benchmark rate at 0.25 percent. Ian McCafferty and Michael Saunders maintained their push for a 25 basis-point increase, which would reverse the rate cut put in place after the Brexit vote in 2016.
While leaving the European Union has cast a shadow over the economic outlook, the resulting drop in the pound has also pushed up inflation, creating a difficult balancing act for Carney. The BOE now sees the rate of price gains exceeding 3 percent next month and remaining above the 2 percent target for years.
On Thursday, the MPC also reiterated a warning from its August meeting that monetary policy could need to be tightened “by a somewhat greater extent” than market rates imply. That statement by itself did nothing to shift markets, unlike the latest comments.
The pound was up 1.2 percent to $1.3371 as of 3:20 p.m. London time. The odds on a 25 basis-point-rate increase by November rose to about 50 percent following the announcement compared to 40 percent just beforehand. A hike is fully priced in for February 2018.
“The BOE have been upping the rhetoric and this was one of the final hurdles in
their communication steps,” said Jordan Rochester, a foreign-exchange strategist in London at Nomura. The bank’s economists predict a hike at November’s meeting.
There’s a history of false dawns when it comes to Carney and rate increases. In June 2014, he said that rates could rise sooner than markets expected, though the BOE never followed through, ultimately loosening policy two years later after the Brexit vote. However, the economic backdrop has changed since. Inflation, below 2 percent back then, is now closer to 3 percent, and unemployment has fallen sharply to below the BOE’s equilibrium level.
In its latest analysis, the MPC said the amount of spare capacity appears to be disappearing more quickly than anticipated. BOE staff see overall economic growth on track for 0.3 percent in the third quarter.