Pounds jumps 1% as governor says Bank is ‘beginning to shift’ on when to raise rates, with a rise possible ‘in coming months’ to stem inflation
The Bank of England has raised the prospect of an interest rate rise as early as November, in an attempt to relieve the squeeze on living standards from surging prices and sluggish wage growth.
On Thursday, Threadneedle Street left interest rates at their record low of 0.25% amid fears over Brexit, but dropped a heavy hint that the first increase in the cost of borrowing for a decade may come sooner than expected if the economy continues to strengthen.
Financial markets now suggest there is a 42% chance of a rate increase in November, up from just 18% a week ago. The odds on a December rise are now 54%.
The squeeze on households and a strengthening economy mean “some withdrawal of monetary stimulus was likely to be appropriate over the coming months”, the Bank said. It added that a majority of the interest rate setting committee agreed with that assessment, and the governor, Mark Carney, later confirmed that he shared the majority view.
The pound jumped more than 1% against the dollar and the euro as the financial markets digested the impact of the comments. Such strong hints on likely rate changes are not usual.
Raising the cost of borrowing would reverse the emergency rate cut introduced by Carney in August 2016 in the wake of the Brexit referendum. It would also raise the cost of mortgages for the first time for millions of homebuyers who have never experienced a rise in their monthly repayments as a result of a rate change. Nationwide’s base mortgage rate would rise from 2.25% to 2.5%, meaning repayments on a £100,000 mortgage would rise £13 a month to £449. A £200,000 mortgage would go up by £25 to £897.
The Bank’s monetary policy committee (MPC), which sets borrowing rates, was split, with the external economists Michael Saunders and Ian McCafferty calling for an immediate rise to 0.5% to keep inflation in check.
In a television interview after the decision, Carney said he and the MPC were “beginning to shift” on when to raise rates. “We will take that decision based on the data. I guess that possibility has definitely increased,” he said.
Explaining its view, the Bank pointed to encouraging recent indicators of economic strength. Data this week showed unemployment has reached a 42-year low of 4.3%, while there are signs household consumption is stronger than expected and the weaker pound is also expected to boost British trade.
However, despite the very low levels of unemployment, wages have yet to move significantly higher. The Office for National Statistics found average earnings had risen by just 2.1% in the three months to July, leaving workers facing a 0.4% real-terms fall in the value of their pay packets .
Sebastian Burnside, senior economist at NatWest, said: “How do you resolve this dilemma? ‘Not just yet’ seems to be the verdict of the MPC. They want to wait to see some more wage growth, but are prepared to act before it really takes off.”
The Bank said there were “considerable risks” on the horizon as ministers hold talks in Brussels over exiting the European Union. This could feed through to damage the economy if households, businesses and the financial markets react badly to the faltering progress.
The Bank’s MPC said: “The circumstances since the referendum on EU membership, and the accompanying depreciation of sterling, have been exceptional.”
Sharply rising inflation has put pressure on the MPC to increase the base rate in recent weeks, as households come under pressure from prices rising faster than earnings. Consumer prices were 2.9% higher in August than in the same month a year ago, after standing at 2.6% in July. The MPC expects inflation to increase further still in the coming months with the consumer price index likely to top 3% in October.
The Bank has a mandate to target an inflation rate of 2% and increasing the base rate could reduce that rate.
Although GDP growth in the first months of the year was at the slowest pace since 2012, there are signs that there will be a faster pace of expansion in the second half of the year. However, given the uncertainty about the type of Brexit deal ministers will be able to forge with Brussels, the Bank said it must strike a fine balance between cutting inflation and maintaining its support for jobs and business activity through the cheaper cost of borrowing. It is also maintaining its £445bn quantitative easing programme.
The MPC said: “During the negotiation period, those economic implications would be influenced significantly by the expectations of households, firms and financial markets. [The Bank must] take account of these evolving expectations in setting monetary policy insofar as they affected the outlook for activity and inflation.”