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London - Bank of England policy makers raised interest rates for the first time in a decade, yet showed concern for Britain’s Brexit-dented economy by indicating that another increase isn’t imminent.
Led by Governor Mark Carney, the Monetary Policy Committee (MPC) voted 7-2 to increase the benchmark rate to 0.5% from 0.25%. The minutes underscored worries that the economy is fragile as the 2019 split with the European Union nears.
Crucially, policy makers omitted language from previous statements saying that more hikes could be needed than the markets expect. That implies that officials are comfortable with pricing for two more quarter-point increases, roughly one by late next year and another in 2020.
Thursday’s decision removes the emergency stimulus introduced in the wake of last year’s EU referendum. It will push against the fastest inflation in five years, boosted by a weaker currency. The additional complication is that underlying price pressures aren’t stemming from stronger demand, but flaws in the economy aggravated by Brexit, namely weak productivity.
“A majority of members judged that a small reduction in stimulus was therefore warranted at this meeting to return inflation sustainably to target,” the MPC said. “Monetary policy would continue to provide significant support to jobs and activity in the current exceptional circumstances.”
Rate Outlook
The bank kept its forecasts for growth and inflation broadly unchanged and sees price gains at 2.2 in three years, slightly above its 2% target. The estimates are based on market projections for the key interest rate reaching 1% over that period.
The bank kept its bond programs unchanged and reiterated that any future interest-rate increases will be limited and gradual.
That was followed by a gloomy section in its statement that there are “considerable risks” to the outlook. Brexit featured prominently in the warning, with policy makers saying they’re ready to respond if it affects households, businesses and inflation.
READ: UK Parliament pushes May to release Brexit impact studies
For the doves on the committee, Jon Cunliffe and Dave Ramsden, there was little sign of domestic costs and wages picking up and they saw a chance slack was greater than estimated. But for the majority, the erosion of slack and continued economic momentum justified action.
The rate increase will hit mortgage holders, a fifth of whom have never experienced a BOE rate hike, according to the bank’s estimates. The effect will be gradual overall because so many borrowers are tied to fixed rates, it said.
False Alarm
The decision to hike comes after multiple false alarms from Carney since he took over as governor in 2013, most notably in 2014 when his whipsawing of investors led to him being tagged an “unreliable boyfriend.”
The BOE’s forecasts see relatively steady growth over the next three years - about 1.7% - but it’s far below the pre-crisis average of 2.9%.
To put the MPC’s dilemma in context, never in its 20 years of independence has it tightened when GDP data was so weak. At 0.4% in the third quarter, it was a 19th consecutive expansion, but below the average of the past five years.
The economy performed better than the bank forecast in the wake of the Brexit vote in 2016, but leaving the EU remains clouded in political uncertainty. There is little insight yet into what form the split will take, let alone Britain’s future relationship with its biggest trading partner.
The big risk is the final deal chills foreign investment, hurts commerce and closes off a supply of vital labour. Such weaknesses would consign a lower “speed limit” on the economy, with repercussions for incomes, demand and long-term potential growth.
The BOE’s step into tightening territory sets it on a path already well-trodden by the Federal Reserve, although it’s responding to economic strength.
After a meeting at the US central bank this week, officials signaled they remain on track to hike for a third time this year in December. The U.S. economy is forecast to expand 2.2% this year, outpacing the U.K.
- With assistance from Jill Ward, David Goodman, Andrew Atkinson, Harumi Ichikura
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