Investment Clock insights

One down, more to come?


Ian Kernohan, Economist

2 November 2017

For the first time since July 2007, the Monetary Policy Committee (MPC) voted to raise Bank Rate by 25bps to 0.5%. The move was widely expected, as was a split vote, so markets were most interested in what happens next.  Here the message from the MPC was mixed.  On the one hand, the Consumer Price Index (CPI) projections in the Inflation Report do not suggest this is a “one and done” move:  the market curve assumes two more hikes over the three year forecast period to get CPI almost back to target.

 

On the other hand, the MPC have dropped their claim that interest rates might have to rise more quickly than the market expects, and perhaps more significantly, there was a lengthy discussion on Brexit risks.
“The decision to leave the European Union was already having a noticeable impact on the economic outlook. The overshoot of inflation throughout the forecast predominantly reflected the effects on import prices of the referendum-related fall in sterling. Uncertainties associated with Brexit were weighing on domestic activity, which had slowed even as global growth had risen significantly.” 
Why tighten now, given the economy appears soggy and Brexit outcomes so very unclear?  On current estimates of GDP (which may be revised) growth rates are certainly low relative to historic norms, however these norms may no longer be appropriate if trend growth has fallen. Unemployment is at a four decade low, employment and vacancies are at record highs, and there are some signs that wage growth is now responding.  In short, slack in the economy appears limited.
Our own view is that while this is not a “one and done” signal, we do expect rates to rise much more slowly than in previous hiking cycles.  With the hike now out of the way and a follow-up hike in February unlikely, this should act as constraint on sterling strength.

 

 

 

 

 

 

 

 

On the other hand, the MPC have dropped their claim that interest rates might have to rise more quickly than the market expects, and perhaps more significantly, there was a lengthy discussion on Brexit risks.

“The decision to leave the European Union was already having a noticeable impact on the economic outlook. The overshoot of inflation throughout the forecast predominantly reflected the effects on import prices of the referendum-related fall in sterling. Uncertainties associated with Brexit were weighing on domestic activity, which had slowed even as global growth had risen significantly.” 

Why tighten now, given the economy appears soggy and Brexit outcomes so very unclear?  On current estimates of GDP (which may be revised) growth rates are certainly low relative to historic norms, however these norms may no longer be appropriate if trend growth has fallen. Unemployment is at a four decade low, employment and vacancies are at record highs, and there are some signs that wage growth is now responding.  In short, slack in the economy appears limited.

Our own view is that while this is not a “one and done” signal, we do expect rates to rise much more slowly than in previous hiking cycles.  With the hike now out of the way and a follow-up hike in February unlikely, this should act as constraint on sterling strength.

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.