Mark Carney: Two more rate rises needed to stop economy ‘running too hot’

November 10th, 2017

Bank of England governor Mark Carney has stressed the “gradual pace” of future interest rate increases, with the central bank’s forecasts now founded on two more hikes over the next three years.

Following the announcement of the Bank’s decision to increase rates from 0.25% to 0.5% today – the first rise in a decade – Carney reiterated the BoE is “easing our foot off the accelerator”, after almost of decade of ultra-low interest rates.

He said the UK needs to see two further rate increases over the next three years in order to return inflation to its target of 2% and prevent the economy from running “too hot”.

Carney added that the “sheer novelty of a rate rise creates uncertainty over the impact but we are well positioned for a rate rise”.

A total of seven members of the committee voted for an interest rate rise today, while just two members voted for rates to remain at 0.25%. At its last meeting in September, only Ian McCafferty and Michael Saunders had voted for a rise.

A statement from the BoE said: “The MPC now judges it appropriate to tighten modestly the stance of monetary policy in order to return inflation sustainably to target.”

“All members agree that any future increases in Bank Rate will be at a gradual pace and to a limited extent,” it added.

In particular, the MPC noted challenges to the UK economy, including the ongoing Brexit negotiations.

Sterling dropped sharply following the announcement, falling 1.1% to $1.31, while the FTSE 100 climbed 0.74% to 7,544 points.

Today’s increase is a reversal of the rate cut Bank of England governor Mark Carney implemented last year in the wake of the Brexit vote, which rocked markets and caused sterling to plummet.

This is the first time rates have been raised since July 2007, when they were increased by 0.25% from 5.5% to 5.75%.

However, as the global financial crisis began to unfold the BoE, then led by Mervyn King, rates began moving downwards and on 8 October 2008 central banks around the world cut rates in a coordinated move as the crisis peaked.

Since March 2009, rates have been at or under 0.5%.

Expert Reaction

Lucy O’Carroll, Aberdeen Standard Investments’ chief economist 

“The risk is that this is interpreted as the start of a cycle of rate hikes, which could knock consumer confidence at a particularly vulnerable time for the economy. Inflation has risen sharply, but this is down to temporary factors. The fact remains that wages are not increasing much and nor are underlying prices, so further substantial rate rises would not be warranted at this stage.

“The most important question for Carney is what they will do if Brexit is not as smooth as his forecasts currently allow for. This small rate rise does not give much room to cut aggressively if the economy turns. The Bank could restart quantitative easing, but their toolbox is really pretty bare.”

John Hussellbee, head of multi-asset at Liontrust

“This was the Bank of England’s first interest rate rise since 2007 and debate has turned to whether this marks the start of a sustained tightening cycle or simply represents a reversal of what critics now largely consider a premature cut in the aftermath of Brexit.

“For my part, I would veer towards the latter. Despite some initial panic after the Brexit vote, the rate cut increasingly seemed unnecessary based on the market and economy’s subsequent performance. The Bank of England appeared keen to get the level back up to 0.50% at the earliest opportunity and a pick-up in inflation has provided this.”

Craig Veysey, manager of the Sanlam Strategic Bond fund

“While some Bank of England MPC members – even among the most dovish – have been talking up more than one hike, we do not think the committee will be in a rush. The authorities will likely want to see the impact on consumers and households with variable rate mortgages.

“We would expect a pause until this coming May, at the earliest. The BoE will tread a similar path as the Fed the first time it hiked. While the Fed initially indicated it wanted to do more, it was cautious and only raised rates again one year later.

“We do not believe the most dovish members of the MPC have fully embraced more rate hikes just yet; particularly as the UK still faces serious concerns, such as Brexit. Nevertheless, these uncertainties will likely result in more bond and currency market volatility – which will create opportunities for investors.

“As for gilts, the concerns about the UK economy will likely cap yields. It is worth remembering that we have become accustomed to low rates. If sterling rises on the expectation of rate increases, it will dampen inflation and mean there is less of a need to continue hiking rates.”

AJ Bell’s investment director Russ Mould

“A very gradual series of rate increases looks unlikely to rock the boat too much, at least for now, although if the Bank is right and inflation is coming then investors may need to revise their stock-picking strategy, shifting from growth stocks (like technology) and high-yielding names to more cyclical or value names, like real estate plays or oils and miners, as well as index-linked bonds.

“Note that LIBOR – the interest rate at which banks are prepared to lend to each other – is just 0.75% for 12 months’ time, implying the market expects just one more 0.25% rate rise by this time next year.”

Nick Dixon, investment director at Aegon, said:

“Although the size of the increase is modest, we see this as the first of many steps and the announcement marks the beginning of the end for cheap money. Inflation continues to exceed its 2% target and there is a risk of elevated inflation becoming embedded through wage increases and pressure to raise public spending.

“Without the political capital to match additional spending with higher taxes, the budget deficit will widen and looser fiscal policy will lead to higher interest rates which we believe will exceed market expectations.”

Shilen Shah, bond strategist at Investec Wealth & Investment, said:  “The key driver for the increase in interest rates was the central bank’s more downbeat view on the economy’s growth potential, with the inflation forecast broadly unchanged from August.

“With the slack in the economy now significantly reduced and sluggish business investment limiting the economy’s output potential, even a moderate rate of growth has the potential to generate core inflation in the medium and the long term. As previously communicated, the BoE expects further interest rate increases to occur at a gradual pace and to a limited extent.”

Widely Predicted

Today’s move had been widely predicted by the market and economists following more hawkish comments by governor Mark Carney in recent months as he hinted at hikes ‘in the coming months’.

CPI inflation rose to 3% in September and the UK economy grew by 0.4% in Q3, giving further reason for economists to increase the likelihood of a rate rise to 84%.

However, speaking to the Treasury Select Committee in October, Carney ruled out raising rates for the sake of it in order to be able to reduce them if there was another recession.

“Building a war chest in interest rate terms for a potential future shock, is not staying on point in terms of the inflation target, nor is it appropriate or necessary given that policy can move quite nimbly if required,” he said.

 

Source: Professional Adviser