Investment Clock insights

Door to rate hike in May now open

Ian Kernohan

8 February 2018

The latest Bank of England Inflation Report raises the risk of a rate hike in May significantly, assuming there is no major economic surprise between now and then. The Monetary Policy Committee (MPC) have stated clearly that monetary policy needs to be tightened somewhat earlier, and by somewhat more than anticipated in November, when they signalled just a few hikes over a three year period.  Recent data has led them to upgrade their GDP forecast to 1.8% in 2018.  This is still quite a modest rate of growth relative to history, however the Bank believes that trend growth has fallen to just 1.5%, thanks mainly to a shortfall in productivity growth. Inflation is expected to fall back gradually, thanks to an unwind of the impact of sterling’s devaluation, but is still expected to be above the 2% target in three years’ time, based on an implied interest rate profile of just one rate hike by Q1 2019, which was our existing base case. 

The MPC notes some firmness in wage growth and expects pay growth to rise further in response to a tighter labour market. They have reduced their estimate of equilibrium unemployment rate to 4.25% from 4.5%, which is in line with the current rate.

What would change their signal re-May hike? The main candidate is a growth undershoot, however they have set the bar on this quite low already. A break down in Brexit talks is another possible candidate, however the Governor has been at pains to point out that the implications of the various Brexit outcomes are not straightforward for monetary policy. 

The MPC have reiterated that any interest rates rises will be at gradual pace and to a limited extent. We take “gradual” not to mean once a quarter, and we now have two hikes instead of one in our 2018 profile (May & November). Our base case assumes continued strong global growth. On Brexit, the base case assumes a smooth transition to a Free Trade Agreement plus Implementation Period.

Past performance is not a guide to future performance. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.