This week’s cartoon depicts aptly how roughly half of the UK’s economists and market commentators chose to interpret the Bank of England’s (BoE) formal warning that there may well be a rate hike before the end of this year. Not at the end of 2018 as the markets had up to now priced in, on the back of the weakening economic environment due to the Brexit uncertainties.
To make sense of what is going on, we need to acknowledge the predicament the BoE’s rate setting committee members face. On the one hand, weak business investment and inflation squeezed consumers are hampering the UK’s economy to the point where in growth terms the rest of Europe is suddenly overtaking. This would call for more economic stimulus, i.e. low rates for longer.
On the other hand, the UK’s current inflation issue is almost entirely caused by the weakness of £‑Sterling and the price rising effect this has on all imported goods and services. The BoE is explicitly tasked with guarding the UK’s price stability. The prospect of higher interest rates usually strengthens a currency – this would call for raising interest rates.
With unemployment continuing to fall to lows last seen 40 years ago, and the combination of low rates and improved job security tempting consumers to take on more (credit card) debt than may be good for them once rates do rise, the BoE can also point at further good reasons to raise rates sooner rather than later.
The ideal scenario would be where the central bank could create the expectation of rate rises which strengthens the currency but doesn’t actually have to raise rates which may still be harmful for the wider economy. On the face of it the BoE succeeded in achieving exactly that this week – despite all the talk that they are bluffing.
In our opinion this was mainly achieved by one of their most academically astute external committee members – Gertjan Vlieghe – in a speech presenting a cohesive argument why rate rises may be necessary now and at the same time not become an issue for the economy (more on the subject in the second article of this week’s edition).
