The Bank of England has put borrowers on notice for an interest rate hike earlier than expected, stoking expectations for an increase as early as May, as the economy accelerates with help from booming global growth.
Threadneedle Street said it would need to raise rates to tackle stubbornly high inflation “somewhat earlier and by a somewhat greater extent” than it had anticipated towards the end of last year.
While the Bank’s rate-setting monetary policy committee (MPC) voted unanimously to leave rates at 0.50% this month, the tone of its discussion suggests the cost of borrowing will not remain this low for much longer.
The Bank’s governor, Mark Carney, had previously suggested there could be two further rate hikes to curb inflation over the course of the next three years – but speculation will now mount over the chance of additional rate hikes.
Before Thursday, City investors had given a 50-50 chance of a rate hike in May, when the Bank will release its next inflation forecasting report. Threadneedle Street said the biggest uncertainties facing the economy came from the Brexit talks, and added that any future rate hikes would come at a “gradual pace and to a limited extent”.
The Bank’s central forecast in its February inflation report signals the economy is growing at almost full capacity.
Threadneedle Street said inflation would fall more gradually than it had previously anticipated, as workers’ pay slowly begins to pick-up and as the oil prices rises. “The outlook for growth and inflation [is] likely to require some ongoing withdrawal of monetary stimulus,” the MPC said.
Although the consumer price index reached 3.1% in November and is forecast to fall over the coming year, as the effects of the weak pound following the Brexit vote begin to fade, the Bank said it is likely to remain well above the government’s 2% target.
Writing to the chancellor, Philip Hammond, to explain why inflation was more than one percentage point outside the government’s target, Carney said it was now “appropriate to set monetary policy so that inflation returns sustainably to its target” after previously having left the rate unchanged to support jobs and growth.
A sustained upswing in global economic activity over the past year – led by the eurozone and stronger growth in the US and China – has helped to prevent a sharper Brexit-related slowdown in Britain. According to the National Institute of Economic and Social Research, the UK economy would have grown at about 1.2% last year instead of 1.8% without the help of the improving global economy.
Britain grew at its fastest rate in 2017 in the final quarter of the year, after a slump prompted by a slowdown in consumer spending earlier in the year, but is now forecast to rebound with the help of global trade. That is despite tough conditions for British households under intense pressure since the Brexit vote as the weak pound pushes up the cost of importing food and fuel.
Brexit uncertainty has constrained the speed at which the UK can grow before prices begin to spiral, according to the Bank, which said the growth potential of the economy had been clipped below the levels it was able to achieve in previous years.
Threadneedle Street reckons annual GDP can rise by 1.5% before generating increased inflationary pressures, but estimates growth will average about 1.75% each year until 2021.
Worries over rising inflation have spooked financial markets in recent weeks, pushing up bond yields and triggering a sell-off in shares, as investors speculate how fast central banks will tighten monetary policy. Although most of the focus has been on the Federal Reserve and the arrival of its new chairman, Jerome Powell, the Bank’s latest inflation report is likely to be seized on by the City.
However, the MPC said it was too early to gauge how large and persistent market corrections were likely to be. “Notwithstanding recent volatility in financial markets, global financial conditions remain supportive,” it added.