As expected, the Bank of England moved this week to raise interest rates. The 0.25% increase – the first rise in over ten years – reverses last year’s emergency rate cut, and means that the Bank of England base rate now stands at 0.5%, barely moving the dial for cash savers. The nine member committee voted 7-2 in favour of the hike, signalling broad-based support for the move, and follows recent data which showed that inflation is running a full percent above the Bank’s 2% target.
As is typically the case with Central Bank announcements, the devil is in the detail, as opposed to the headlines. In this regard, the minutes from the meeting and the accompanying inflation report provided a more downbeat outlook for interest rates going forward, signalling that it is too early to expect any significant normalisation of monetary policy any time soon. The Bank is forecasting that the UK will grow at around 1.7% per annum over the next three years – steady, but significantly below the economy’s pre-crisis average of around 2.9%, and they remain of the opinion that there are “considerable risks” to the outlook. Under their forecasts, inflation will moderate to 2.2% over the next three years, in touch with its target.
The market interpreted this announcement and the accompanying report to mean that the pace of interest rate rises in the UK will turn out to be lower than expected over the next three years, and has moved to price-in only two more rate increases over this period. Currency markets reacted accordingly, with Sterling falling by two cents against the Dollar to below $1.31. This galvanised parts of the UK equity market benefiting from a weaker currency (namely those companies which generate the majority of their earnings from overseas markets), and helped the FTSE 100 rally by nearly 1% on the day. Yields on UK Government Bonds also declined, with the yield on the 10 bond falling to 1.26%. Whilst the UK economy has performed better than expected post the Referendum, questions remain about its sustainability and fragility – this is the first time in its twenty years of independence that the Bank has tightened policy when GDP was this weak (0.4% in the third quarter of 2017).
Staying with Central Banks, US President Donald Trump has named Jay Powell as his nominee to serve as the next chair of the Federal Reserve when current incumbent Janet Yellen’s term ends in February 2018. Mr Powell has been a serving Fed Governor since 2012, and is seen as being a more cautious and a less disruptive appointment than other candidates for the role. Time will tell if this proves to be the case. Separately, the Federal Reserve kept monetary policy unchanged at its meeting this week, signalling that gradual rate increases lie ahead. Currently, the market puts the probability of a rate increase in December at 87%.