Bank of England Interest Rate Outlook
Back in 2009, when the global economic crisis was at its peak, the Bank of England (BoE) slashed the benchmark interest rate to 0.5% – the lowest level recorded since 1694. Over the course of the previous six months the central bank had slashed rates six times, taking them from 5% to the record low in an attempt to shore up the UK’s economy in a time of worldwide financial turmoil and bring the rate of inflation in line with the BoE’s 2% target.
The action took the Pound Sterling to Euro (GBP/EUR) exchange rate to €1.13.
The Eurozone, the UK’s biggest trading partner, was on the verge of collapse and nations from the US to Australia were reeling from the collapse of the Lehman Brothers financial services firm and the subsequent loss of confidence among both investors and consumers.
At the time Mervyn King, former BoE Governor, asserted; ‘The Bank of England remains committed to improving liquidity in credit markets that are not functioning normally.’
Over the last five years the global economic outlook has improved considerably. The UK has returned to pre-crisis levels of growth, with the services, manufacturing and construction sectors all returning to expansion territory.
For a time it even appeared that the Eurozone was on the up and up, and investors began to speculate that the BoE could hike borrowing costs before the close of 2014.
Over the course of 2014 various policymakers, officials and economists have all offered their perspective on the direction the central bank should take, and the conflicting commentary has had a significant impact on the Pound Sterling (GBP) exchange rate.
Since interest rate rhetoric began to dominate financial news the GBP/EUR exchange rate has hit lows of €1.17 and peaked at €1.29.
However, as the year progressed the situation began to deteriorate.
UK Inflation Rate Falls and Undermines Employment Gains
The pace of UK growth is slowing, inflation is moving further away from the central bank’s 2% target, wage growth is stagnating and the Eurozone is on the verge of entering a triple dip recession.
Consequently, expectations for the first interest rate increase have been pushed back from November of this year to, firstly, the spring of next year and now the summer following the general election.
Although the BoE’s Monetary Policy Committee (MPC) has, for the first time in several years, been divided on the subject of interest rate rises, the central bank’s chief economist recently issued a damning condemnation of the outlook for borrowing costs.
Andrew Haldane caused Pound Sterling (GBP) losses and a slide in confidence when he asserted that UK data was disappointing. He went on to note; ‘Put in rather plainer English, I am gloomier. This implies interest rates could remain lower for longer, certainly than I had expected three months ago.’ His remarks came on the back of the news that the pace of UK inflation had slowed to a five-year low of 1.2%.
Haldane’s statements were more pessimistic than those released by BoE policymaker Martin Weale earlier in the week. Weale intimated that immediate interest rate increases are a necessity if the UK is to counter future consumer price pressures.
His hawkish stance has led investors to bet that the MPC will have remained divided at their most recent policy meeting, the minutes of which are due for publication later today.
Expert Opinions on BoE Interest Rates
Chancellor of the Exchequer George Osborne observed: ‘Interest rates are entirely a matter for the independent Bank of England, the monetary policy committee there. I’ll say this about the economy more generally – there are clearly a lot of global risks out there at the moment – we see these problems in the European economy, we’ve got this horrific disease Ebola in West Africa, all the problems in the Middle East and in the Ukrainian border. The global economy is more unstable than it has been for some time. That is all the more reason why in the UK we have to stick to the stability we have won.’
Howard Archer of IHS Global Insight stated; ‘With earnings growth currently still weak, consumer price inflation down to 1.2% in September and likely to go lower still in the near term given the marked weakening of oil prices, and with global growth concerns (particularly the weakness in the Eurozone) posing an increased downside risk to the UK growth outlook, we suspect that the majority of MPC members will prefer to err on the side of caution in raising interest rates.’
Archer continued: ‘At this stage though, we doubt that the Bank of England will delay raising interest rates past mid-2015, as we do expect UK growth to hold up relatively well over the coming months, barring a major global downturn. We now expect interest rates to only rise to 1.00% by the end of 2015 instead of 1.25%. We still expect interest rates to rise gradually to 2.00% by end-2016 and to 3.00% by end-2017.’
Markit economist Chris Williamson noted; ‘While a few months ago, the likelihood was growing that the Bank might need to hike interest rates in late-2014 or early next year, the data are now stacking up to suggest a hike could be delayed at least until next summer, after the general election’.
So is the BoE Likely to Hike Interest Rates before the UK General Election?
Some investors haven’t completely ruled out the prospect of an interest rate increase taking place in November. If nothing else, it would help the BoE avoid getting caught up in interest rate arguments during the upheaval of the UK general election.
However, if the next batch of inflation and wage growth figures disappoint, the central bank is highly unlikely to take decisive action.
Given that some industry experts have implied that BoE Governor Mark Carney is strategically keeping interest rates on hold until after the election as a form of political maneuvering, the central bank may want to assert its independence by increasing borrowing costs in spring.
That being said, the odds are stacking up in favour of interest rates being increased from 0.5% in the summer.
Will the Pound Sterling Exchange Rate Rise or Fall?
If today’s minutes show a divide in the MPC of 2:7 or higher, it would represent confidence among policymakers that the UK could withstand rate an increase in borrowing costs. Such an event would see the Pound Sterling exchange rate advance on peers like the Euro (GBP/EUR) to US Dollar (GBP/USD).
In the short term the Pound will remain reactive to UK economic reports. Below forecast ecostats are likely to undermine demand for the British currency, while signs that the recovery still has legs would push Sterling higher.
In the long term any solid signs that the BoE is preparing to increase interest rates could see the Pound Sterling exchange rate trending higher, but the currency is likely to remain under pressure until a decision is announced.
UPDATE
GBP/USD, GBP/EUR Decline after BoE Minutes
After the release of the Bank of England’s meeting minutes the Pound shed over 0.3% against the Euro and 0.4% against the US Dollar.
Sterling was broadly softer as the minutes confirmed that the divide in the Monetary Policy Committee remained at 2:7.
The minutes also outlined policymakers concerns regarding the slowdown in the Eurozone and the impact the currency bloc could have on the UK’s own recovery.
The pessimistic overtone to the minutes also saw the GBP/AUD and GBP/NZD exchange rates fall by over 0.6% during the European session.
UPDATE
Expert Reaction to BoE Minutes
According to strategist Martin Peck; ‘What we have seen is a validation of the current market assessment, that there will be moves later on in 2015.’
Economist Ross Walker noted; ‘The impression gleaned from the October MPC minutes is that the majority opposing early hikes are becoming more entrenched. The overall hawkish drift within the committee in previous months has been halted.’
Finally, Societe Generale said this; ‘The window of opportunity for a pre-election hike is fading fast and thereafter, how far rates can rise as growth slows and fiscal policy is tightened must be questionable.’
The Pound Sterling (GBP) exchange rate continued trending lower against its rivals as the minutes were digested.
UPDATE
The odds of the Bank of England bringing forward its timeline for increasing interest rates fell further still on Thursday after UK retail sales were shown to have fallen by -0.3% on the month in September. This sign of reduced consumer demand is unlikely to make policymakers believe that the public would react well to higher borrowing costs.
After the sales report was released the GBP/EUR exchange rate hit a low of 1.2628
UPDATE
On Friday data confirmed that the pace of UK growth slowed in the third quarter of the year, easing from 0.9% to 0.7%. The result was in line with expectations but is unlikely to convince BoE policymakers that the timeline for increasing UK interest rates needs to be brought forward.
If the rate of expansion continues to slow in the final quarter of the year, the first BoE rate hike isn’t likely to take place until next summer.
