Thursday, June 21, 2018

UK's BOE maintains rate but MPC votes 3-6 for hike

      The U.K. central bank left its benchmark Bank Rate at 0.50 percent but 3 members of its 9-member monetary policy committee (MPC) voted to raise the rate immediately as they were highly confident the economic slowdown in the first quarter was temporary and a modest tightening now would help avoid a rise in inflation that would then lead to higher rate hikes that end up triggering sharp falls in growth and employment.
      At the previous MPC meeting in May only two external members - Ian McCafferty and Michael Saunders - had voted to raise the Bank Rate by 25 basis points but they have now been joined by Andrew Haldane, chief economist of the Bank of England (BOE).
       In the run-up to the May meeting, early expectations the BOE would raise its rate for the second time since November 2017 were dashed after it became clear the economy had slowed sharply in the first quarter.
      Investors questioned whether the BOE was correct in considering this slowdown as temporary and began wondering whether it would have to postpone any rate hikes to 2019.
       Slower than expected growth in the euro area, a soft patch in China and a reversal of capital flows to some emerging markets amidst robust U.S. growth reinforced investors' nervousness and this accelerated the fall in the pound's exchange rate along with a broad rise in the U.S. dollar.
       Today the BOE answered many of these questions, saying recent data confirmed that "the slowdown in Q1 had been temporary," and the collective judgement of the MPC remains that "an ongoing tightening of monetary policy over the forecast period would be appropriate to return inflation sustainably to its target..."
       News since the May meeting had given the majority of the MPC "greater reassurance that the softness of activity in the first quarter had been largely temporary," as household consumption and sentiment had "bounced back strongly from what appeared to be erratic weakness in Q1, partly related to the adverse weather."
       The reaction of currency markets to the BOE's decision was immediate, with the pound jumping 1.5 percent to 1.31 per U.S. dollar. The pound is now up 3 percent since the start of this year.
       After slumping to quarterly growth of only 0.1 percent in the first quarter, the BOE said its staff expected second quarter Gross Domestic Product growth of 0.4 percent, in line with its May estimate,  and growth in unit wage costs had appeared to pick up.
       Headline inflation and core inflation was steady in May and April at 2.4 percent and 2.1 percent, respectively, both 0.1 points higher than expected in May, with the fall in the pound tending to push up inflation further ahead.
       Although growth in the U.K. is modest by historical standards and forecast to average around 1.75 percent in the next few years, it is still above the diminished rate of supply, resulting in a small margin of excess demand by early 2020. This feeds into higher wages and costs.
        In addition to deciding on the Bank Rate, the MPC also looked at its stock of assets that it has purchased in recent years - a policy known as quantitative easing - in order to hold down long-term interest rates and stimulate the economy when policy and short term rates are already very low.
       Under a policy from 2015, the BOE had planned to not reduce its stock of 435 billion of U.K. government bonds and 10 billion of corporate bonds until the Bank Rate reached around 2.0 percent.
       But reflecting the rate cut in August 2016, in the wake of the U.K.'s Brexit vote, the effective lower bound of the Bank Rate has fallen and the BOE may now decide to reduce its stock of assets at a gradual and predictable pace once the Bank Rate has reached around 1.5 percent.

      The Bank of England issued the following statement:

"The Bank of England’s Monetary Policy Committee (MPC) sets monetary policy to meet the 2% inflation target, and in a way that helps to sustain growth and employment.  At its meeting ending on 20 June 2018, the MPC voted by a majority of 6-3 to maintain Bank Rate at 0.5%.  The Committee voted unanimously to maintain the stock of sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, at £10 billion.  The Committee also voted unanimously to maintain the stock of UK government bond purchases, financed by the issuance of central bank reserves, at £435 billion. 

In the MPC’s most recent projections, set out in the May Inflation Report, GDP was expected to grow by around 1¾% per year on average over the forecast, conditioned on the gently rising path of Bank Rate implied by market yields at the time.  In those projections, growth continued to rotate towards net trade and business investment and away from consumption.  While modest by historical standards, the projected pace of GDP growth over the forecast was nevertheless slightly faster than the diminished rate of supply growth, which averaged around 1½% per year.  As a result, a small margin of excess demand was projected to emerge by early 2020, feeding through into higher rates of pay growth and domestic cost pressures.  Nevertheless, CPI inflation continued to fall back gradually as the effects of sterling’s past depreciation faded, reaching the 2% target in two years.

A key assumption in the MPC’s May projections was that the dip in output growth in the first quarter would prove temporary, with momentum recovering in the second quarter.  This judgement appears broadly on track.  A number of indicators of household spending and sentiment have bounced back strongly from what appeared to be erratic weakness in Q1, in part related to the adverse weather.  Employment growth has remained solid.  Although manufacturing output recorded a decline in April, and this was accompanied by a fall in goods exports, surveys of business activity have been stable and, as a whole, point to growth in the second quarter in line with the Committee’s May projections.  

Internationally, activity data have been mixed.  Indicators suggest that US growth bounced back strongly in Q2 from the softness in Q1.  Euro-area growth has been weaker than expected, and downside risks have increased in some emerging markets, in part reflecting tighter financial conditions.  More broadly, the prospects for global GDP growth remain strong, and while financial conditions have tightened somewhat, they continue to be accommodative. 

CPI inflation was 2.4% in May, unchanged from April.  Inflation is expected to pick up by slightly more than projected in May in the near term, reflecting higher dollar oil prices and a weaker sterling exchange rate.  Most indicators of pay growth have picked up over the past year and the labour market remains tight, suggesting that domestic cost pressures will continue to firm gradually, as expected.

The Committee’s best collective judgement remains that, were the economy to develop broadly in line with the May Inflation Report projections, an ongoing tightening of monetary policy over the forecast period would be appropriate to return inflation sustainably to its target at a conventional horizon.  For the majority of members, an increase in Bank Rate was not required at this meeting.  All members agree that any future increases in Bank Rate are likely to be at a gradual pace and to a limited extent.

In addition to its discussion of the immediate policy decision, the Committee reviewed its previous guidance on the level of Bank Rate at which the MPC will consider whether to start to reduce the stock of purchased assets.  The MPC continues to expect to maintain the stock of purchased assets until Bank Rate reaches a level from which it can be cut materially, reflecting the Committee’s preference to use Bank Rate as the primary instrument for monetary policy.  Since the previous guidance, the Committee has reduced Bank Rate from 0.5% to 0.25% in August 2016 and has noted that it could lower it further if required.  Reflecting this, the MPC now intends not to reduce the stock of purchased assets until Bank Rate reaches around 1.5%, compared to the previous guidance of around 2%.  Any reduction in the stock of purchased assets will be conducted at a gradual and predictable pace.  Decisions on Bank Rate will take into account any impact of changes in the stock of purchased assets on overall monetary conditions, in order to achieve the inflation target.  In the event that potential movements in Bank Rate are judged insufficient to achieve the inflation target, the reduction in the stock of assets could be amended or reversed."


Post a Comment