First UK rate hike in a decade is probably the last for a while
London — Bank of England policy makers raised interest rates for the first time in a decade, yet expressed concern for Britain’s Brexit-dented economy by indicating that another increase was not imminent.
Led by governor Mark Carney, the monetary policy committee voted 7-2 on Thursday to increase the benchmark rate to 0.5% from 0.25%.
The minutes of their meeting underscored concern that the economy is fragile as the 2019 split with the European Union nears.
Crucially, policy makers omitted language from previous statements saying that more hikes could be needed than financial markets expect.
That implies that officials are comfortable with pricing for two more quarter-point increases, roughly one by late next year and another in 2020.
The more dovish outlook than investors anticipated pushed the pound down nearly 1% against the dollar to as low $1.3096 and gilts rose.
UK money markets pushed back expectations for the next shift to September 2018 from August 2018 previously.
"Interest rates are likely to rise only very gradually over an extended period of time," said Colin Ellis, MD for credit strategy at Moody’s Investors Service. "This benign outlook for interest rates differs from past monetary cycles, when policy rates rose more swiftly and more sharply after they reached their previous floors."
Thursday’s decision removes the emergency stimulus introduced in the wake of last year’s EU referendum.
It will push against the fastest inflation in five years, boosted by a weaker currency and the lowest unemployment rate in four decades.
Inflation is now running a full percentage point above the bank’s 2% target.
The dilemma for the central bankers is that underlying price pressures are not stemming from stronger demand, but flaws in the economy aggravated by Brexit, namely weak productivity.
"A majority of members judged that a small reduction in stimulus was therefore warranted at this meeting to return inflation sustainably to target," the monetary policy committee said. "Monetary policy would continue to provide significant support to jobs and activity in the current exceptional circumstances."
The bank kept its forecasts for growth and inflation broadly unchanged and sees price gains at 2.2% in three years, slightly above its goal. The estimates are based on market projections for the key interest rate reaching 1% over that period.
The bank kept its bond programmes unchanged and reiterated that any future increases in interest rates would be limited and gradual.
The forecasts were accompanied by a gloomy section that there are "considerable risks" to the outlook.
Brexit featured prominently in the warning, with policy makers saying they’re ready to respond if it affects households, businesses and inflation.
For the doves on the committee, Jon Cunliffe and Dave Ramsden, there was little sign of domestic costs and wages picking up and they saw a chance slack was greater than estimated. But for the majority, the erosion of slack and continued economic momentum justified action.
The rate increase will hit mortgage holders, a fifth of whom have never experienced a rate hike, according to the bank’s estimates. The effect will be gradual overall because so many borrowers are tied to fixed rates, it said.
The decision to hike comes after multiple false alarms from Carney since he took over as governor in 2013, most notably in 2014 when his whipsawing of investors led to him being tagged an "unreliable boyfriend".
The Bank of England’s forecasts are for relatively steady growth over the next three years — about 1.7%, which is still far below the pre-crisis average of 2.9%.
To put the dilemma in context, never in its 20 years of independence has the central bank tightened when GDP growth was so weak
To put the dilemma in context, never in its 20 years of independence has the central bank tightened when GDP growth was so weak. At 0.4% in the third quarter, it was a 19th consecutive expansion, but below the average of the past five years.
The economy performed better than the bank forecast in the wake of the Brexit vote in 2016, but leaving the EU remains clouded in political uncertainty. There is little insight yet into what form the split will take, let alone Britain’s future relationship with its biggest trading partner.
The big risk is that the final deal chills foreign investment, hurts commerce and closes off a supply of vital labour. Such weaknesses would consign a lower "speed limit" on the economy, with repercussions for incomes, demand and inflation.
The central bank’s step into tightening territory sets it on a path already well-trodden by the Federal Reserve, although the Fed responding to economic strength.
After a meeting at the US central bank this week, officials signalled they remained on track to hike for a third time this year in December. The US economy is forecast to expand 2.2% this year, outpacing the UK.