Author: Charles PurdyPublished by
As expected, the Bank of England decided to increase rates by 25 basis points to half a percent last Thursday. It was the first rate hike for more than a decade and had been a long time coming.
Indeed, market expectations were such that in the few days running up to the announcement, sterling strengthened against the euro and US dollar. On the eve of the meeting, the pound hit a four-month high against the single currency and, although it later fell back below this level, one thing was clear: the City was expecting an interest rate rise and woe betide the Monetary Policy Committee if they decided to keep rates on hold.
Of course, I say that in jest, but it is true that, in many ways, BoE Governor Mark Carney and the rest of the MPC were obliged to increase rates. For one thing, a chief reason for keeping rates on hold throughout 2017 was that inflation was consistently outpacing wage growth; it was felt that to increase rates would unnecessarily pressure borrowers and cause UK households to feel the pinch even more than they already were.
The ONS Admits They Made A Mistake
So when the Office for National Statistics announced that a mistake had been made in its original unit labour cost data, it suddenly became possible that wage growth could narrow the gap between inflation sooner than expected. The announcement, coming as it did less than a month before the next interest rate decision, piled pressure on Carney and his associates to increase rates from their record low of 0.25%.
In addition, the central bank has a legal mandate to keep inflation at 2% and in September it crept up to 3%; it has to be seen to be doing something to curb inflation when a situation like this arises. There was also the feeling by some that to drop rates to 0.25% following the Brexit vote was an unnecessary knee-jerk reaction in the first place.
Acknowledging A Possibility Is Not Confirmation It Will Happen
Less than a month before last Thursday’s announcement, current market pricing suggested that there was almost a 90% chance that rates would be increased by 0.25%. There were several reasons for this, but Carney’s speech at the 2017 IMF Michel Camdessus Central Banking Lecture in Washington certainly helped boost expectations.
In the speech, Carney said that “Some withdrawal of monetary stimulus is likely to be appropriate over the coming months in order to return inflation sustainably to target,” and that “Monetary policy has to move in order to stand still.”
But then came the words of caution: “Any prospective increases in Bank Rate would be expected to be at a gradual pace and to a limited extent, and to be consistent with monetary policy continuing to provide substantial support to the economy.”
It is remarkable really, to think that an allusion to prospective interest rate rises could be interpreted as a commitment to raising interest rates, but there it was - Carney had made mention of future increases and, despite stating these would only be gradual, the markets took hold and refused to let go.
Echoing Sentiments With Entirely Different Outcomes
The markets had priced in a rate hike and so a significant strengthening of the pound wasn’t altogether expected. Equally surprising was just how much sterling weakened following BoE’s announcement. In the press conference after the central bank’s decision, Carney gave another speech in which he conceded that inflation was unlikely to return to the 2% target unless rates were increased. He then reiterated that any future rates would be gradual and that the Bank’s forecasts were based on two more hikes over the next three years.
The markets did not like that, despite the fact that what Carney said essentially echoed the sentiments expressed in the aforementioned 2017 IMF Michel Camdessus Central Banking Lecture speech. Clearly, timing is everything, because sterling weakened sharply in response. In fact, it lost almost two per cent against the euro and US dollar.
It just goes to show how fickle the markets can be and how nobody can predict what is going to happen to any given currency pairing from one day to the next - a point we make clear in our latest quarterly currency forecasts.
It remains to be seen whether rates will be increased again in the near future, but it appears that not everyone is convinced that raising them in the first place was the right thing to do.
This article was written by Charles Purdy from Forbes and was legally licensed through the NewsCred publisher network. Please direct all licensing questions to firstname.lastname@example.org.
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