Will Super Thursday Live Up to its Name?

BoE Has Prepared Markets For a Rate Hike, Will it Deliver?

On Thursday, the Bank of England is widely expected to do something that a large group of people will never have experienced, raise interest rates.

For the first time in a decade and the first since the global financial crisis, policy makers will discuss the merits of a rate hike in a bid to prevent inflation moving too far above target. Or at least, that’s what we’re being told despite the acknowledgement that higher inflation is almost entirely down to the one-off currency depreciation that occurred since the Brexit referendum last year.

Inflation reached 3% in September, far above the central bank’s 2% target and at the top of the range that the government deems acceptable before Governor Carney must write a letter to the Chancellor explaining why the central bank is failing to achieve its mandated target.

Interestingly, this is also around the level that the central bank expects inflation to peak at which begs the question why they’ve waited so long to raise interest rates. Also, why do they now deem it to be the right time to do so before we have a chance to find out how far it will fall again once the initial impact of the currency move falls out of the calculation?

If Inflation is Above Target, Why is a Rate Hike So Controversial?

As is to be expected in post-Brexit Britain, the decision on whether or not to raise interest rates is far from straightforward. This is clearly evident when listening to one of Carney’s press conferences or appearances before the Treasury Select Committee, as well as in the rhetoric from his colleagues on the Monetary Policy Committee.

Not only does the inflation data and outlook not necessarily warrant a rate increase but the uncertain economic outlook muddies the water even further, which explains the divide on the committee.

It’s quite clear that the economy has slowed since the vote last year, with the country falling from the top of the G7 growth table to the bottom in the first half of the year. Employment may have remained strong for now but with real wage growth having turned negative and spending slowed, it’s clear that the economy is stalling which begs the question, is it really the correct time to raise interest rates?

The argument for the hawks on the MPC is that the economy hasn’t slowed as much as was feared in the months after the referendum – partly due to the actions it took – and so a reversal of the rate cut in August 2016 makes sense.

While this hasn’t been acknowledged by policy makers, there may also be a case that the BoE took a risk when cutting interest rates last year, taking base rate below the level that for the seven years previous was deemed to be the lower bound. Perhaps this is no longer seen as being a risk worth taking.

If this is the case then the BoE may refrain from committing to, or even hinting at, further rate hikes in the foreseeable future, which you would expect if this was in fact the beginning of a tightening cycle. Instead it may opt for the ECB approach of data dependent decision making. In other words, the less we know the better.