United Kingdom: BoE continues wait-and-see approach in June but adopts a more hawkish tone
June 15, 2017
At its meeting ending on 14 June, the Monetary Policy Committee (MPC) of the Bank of England (BoE) voted by a majority of five to three to leave the Bank Rate at 0.25%. The Bank also voted unanimously to continue its purchases of investment-grade corporate bonds to the tune of up to GBP 10 billion and to maintain the total stock of UK government bond purchases at GBP 435 billion, financed by the issuance of Central Bank reserves. All three decisions were in line with market expectations.
Although most members of the MPC opted to stay put, three argued for a rate rise of 25 basis points, which surprised markets, who had expected an overwhelming majority of committee members to back a continuation of current policy. More hawkish members pointed to the fact that inflation has risen faster than expected in recent months, reaching 2.9% in May, substantially above the Bank’s 2.0% target. At the same time, the labor market has continued to tighten, with the unemployment rate remaining at a multi-decade low of 4.6% in April. This suggests spare capacity in the economy is becoming limited, altering the BoE’s trade-off between containing inflation and encouraging economic activity in favor of the former.
On the other hand, economic activity slowed markedly in Q1 on the back of more sluggish private consumption growth. There is no doubt that households are feeling the pinch; growth in retail sales and house prices has dropped off since the start of the year, and real wages are now falling for the first time since 2014. There is also likely to be a prolonged period of heightened political uncertainty on the horizon, after Prime Minister Theresa May recently lost her parliamentary majority and with Brexit talks just around the corner. In addition, the rise in inflation is almost wholly due to the depreciation of sterling and should thus prove to be transient; demand-pull pressures are currently fairly weak and inflation expectations remain well anchored. These factors were enough to convince most committee members to choose to maintain the current expansive monetary stance.
The tone of the communique was more hawkish than at previous meetings, with the BoE highlighting the erosion of slack in the labor market as a sign that the economy is nearing full capacity. This hints at a possible withdrawal of monetary stimulus going forward, although any tightening will be small and gradual. Regarding prices, the Bank admitted that inflation could rise above 3.0% this year, after predicting a mere month ago in May’s Inflation Report that it would peak at slightly below 3.0%. The fall in the value of sterling since the election, if sustained, is also likely to add further impetus to inflation. The Bank has said repeatedly at past meetings that there is a limit to the extent to which above-target inflation can be tolerated; it looks like that limit is not too far away now.
Author: Oliver Reynolds, Economist