Inflation trumps all, at least for some Bank of England policy makers.
Unease about the currency-driven surge in prices unexpectedly prompted three of them to vote for an immediate interest-rate increase this month. In a week that also saw wage growth weaken, retail sales plunge and renewed political instability, it points to growing concern among officials about their ability to keep a lid on prices.
In the biggest division on interest rates in six years, the Monetary Policy Committee voted by five to three to maintain the key rate at a record-low 0.25 percent. Michael Saunders and Ian McCafferty broke ranks to join Kristin Forbes in demanding an immediate hike, as officials warned that inflation — already at 2.9 percent — could accelerate more than previously thought.
“It seems to be that inflation is the thing for them, and that they’re going to watch and wait on everything else,” said Victoria Clarke, an economist at Investec Securities. “It’s almost like the 2.9 percent has set off some alarm bells and got them really thinking about their stance.”
The pound rose after the decision and investors increased bets on a rate increase this year as inflation climbs further above the BOE’s 2 percent target. Swaps data now indicate around a 50 percent probability of hike by the end of 2018, up from 33 percent on Wednesday, though that’s still below expectations earlier in the year.
It’s not just the three dissenters who are worried. Inflation could breach 3 percent by the fall, according to the summary published with the decision, and it’s “likely to remain above the target for an extended period as sterling’s depreciation continues to feed through into the prices of consumer goods and services.”
The MPC also warned that the pound’s decline since its May projections — on a trade-weighted basis the currency is down 3 percent — could add to upward pressure on import prices. Policy makers will publish new forecasts for inflation and growth at their next decision on Aug. 3.
Whether the new hawkish tilt can endure is up for question, with Forbes set to step down from the rate-setting committee at the end of the month. So far, no replacement has been named by the Treasury, which has also yet to fill the role of deputy governor.
The unclear path of Brexit negotiations, after last week’s shock election result weakened Prime Minister Theresa May’s grip on power, is also muddying the water. The BOE said in May that its economic forecasts assumed that Britain’s adjustment to a new relationship with the European Union will be “smooth,” avoiding a so-called cliff edge.
“What is perhaps more surprising is that the hawkish tendencies of the BOE have not been derailed by the return of political uncertainty following the election,” said Michael Metcalfe, global head of macro strategy at State Street Global Markets. “The BOE’s immediate concern on inflation is trumping what potential political fallout there may be on the economic outlook.”
Even with the shift in votes, Jamie Murray at Bloomberg Intelligence says the BOE won’t move faster toward a rate hike and he’s sticking to his view for no change until 2019. The last time the U.K. saw the benchmark increase was in 2007, before the financial crisis struck.
“It’s pretty clear we have a very significant demand shock going on here,” he said on Bloomberg Television. “There’s elevated uncertainty and that hasn’t been helped by the outcome of the election. That’s going to drag on GDP.”