As widely anticipated and well communicated in advance, the Bank of England’s Monetary Policy Committee (MPC) raised its policy rate by 25 basis points to 0.5%. The decision was well supported by the MPC, with a majority voting in favour (7-2).
This is the first increase in the Bank’s key policy rate since July 2007. But, back then the economy was growing at a 2.5% annualized pace, and the policy rate was set at 5.75%, or 525 basis points higher than the current policy rate. In addition, the MPC voted unanimously to maintain their stock of corporate and UK government bond purchases at £10 billion and £435 billion, respectively.
The MPC made it clear that the decision to tighten was due to the shift in the balance of risks around inflation to the upside. Bank of England Staff projections anticipate that headline inflation will peak at just above 3.0% y/y in October, which is just above the operational target range of 1 to 3%. Inflation has been running at the upper end of the range since this past Spring, driven by the pass-through to consumer prices from the post-Brexit referendum depreciation in the exchange rate and a steady move higher in energy. Today’s move is widely viewed by the MPC as necessary to ensure that inflation moves sustainably back down within the target range.
Financial market reaction to the announcement was dovish, sending the pound down by about 1% versus the U.S. dollar in the aftermath of the decision. UK government bonds were bid, with the 10-yr UK government bonds yield falling by over 6 basis points to 1.28.
In the Inflation Report, projections for economic growth have been revised up on a Q4/Q4 basis for 2017 to 1.5% from 1.3%, revised down for 2018 to 1.7% from 1.8%, and unchanged in 2019 at 1.7%. Similarly, the inflation outlook was revised up for 2017 to 3.0% from 2.8%, and revised down slightly in 2018 to 2.4% from 2.5%; the outlook for 2019 was unchanged at 2.2%. The unemployment rate is now expected to hold at 4.2% through 2019, down from the 4.5% level in the August projection. This is consistent with the Bank’s view that tightening labour market will help support wage growth, but low productivity growth will prevent nominal wages from rising persistently above 4.0% as was typical in the pre-2007 era. Low productivity growth is a phenomenon that has been plaguing other advanced economies as well, often being singled out as one of the key reasons as to why wage growth has remained so weak in the past decade despite unemployment rates falling to historic lows.
With today’s decision, the Bank of England joins two of its G7 peers, the Bank of Canada and the U.S. Federal Reserve, in raising its key monetary policy interest rate this year. However, the Bank of England is in the unique situation of raising rates to ensure inflation moves back down to within its target band, while both the Bank of Canada and the U.S. Federal Reserve raised interest rates to head off what they believe to be rising wage and price pressures that will help move inflation up toward target in coming quarters.
