Bank of England freezes key interest rate, but warns of high inflation
London — On Thursday, the Bank of England (BoE) froze its key interest rate but cautioned that it could rise more quickly than expected so as to bring down high inflation.
The BoE’s nine-strong monetary policy committee "voted unanimously to maintain the bank rate at 0.5%", but rates could rise sooner than expected "to return inflation suitably to target", it said in a statement.
The BoE lifted its forecasts for economic growth and suggested it may need to raise interest rates faster than previously indicated. The monetary policy committee (MPC), led by governor Mark Carney, sees the UK growing quicker than its sustainable pace through 2020, meaning there’s a greater risk of overheating.
Inflation is projected to remain above the 2% target under the current yield curve, which prices in about three quarter-point hikes over the next three years. The bank sees inflation at 2.2% in the first quarter of 2020 — above the 2% goal — further indicating it will need to tighten policy faster.
The MPC agreed that "monetary policy would need to be tightened somewhat earlier and by a somewhat greater degree over the forecast period than anticipated at the time of the November report", according to the minutes of its latest meeting published on Thursday.
The pound jumped after the announcement and was up 0.8% to $1.3995 as of 12.03pm London time.
The comments may fan market expectations of a rate hike as soon as May. Bets on such a move increased in the run up to the decision and a number of economists now also see an increase in the first half of the year.
In its updated forecasts, the BoE sees growth at 1.8% this year and next, up from its November projections. While consumption will remain weak and Brexit is damping investment, global demand is helping UK trade, it said.
Policy makers also reiterated that a range of Brexit outcomes are still possible. These developments "remain the most significant influence on, and source of uncertainty about, the economic outlook", they said in their inflation report.
BoE cut its estimate of the equilibrium unemployment rate, or the lowest level of joblessness that won’t trigger quicker wage gains, to about 4.25% from 4.5%. The current rate is 4.3%.
The bank warned there’s little spare capacity left to burn, and the economy’s speed limit, or the rate it can expand without fanning inflation, has dropped to about 1.5% since the Brexit vote. Because of this, all the slack left in the economy will be eroded within two years and excess demand will then start to build.
Since the vote to leave the EU in June 2016, the BoE has said it could tolerate faster inflation driven by the weaker pound to support growth. While it had previously stretched its horizon, seeking to return inflation to target over three years, the stronger growth projection means it is now aiming to get inflation to the goal in two years.
In a letter to Chancellor of the Exchequer Philip Hammond, explaining why the inflation rate had deviated from target, Carney wrote "the prospect of a greater degree of excess demand" had "further diminished the trade-off" that policy makers could accept.
The economy’s scope to comfortably expand has been curtailed because of weak productivity over the past decade. Brexit has added an additional pressure by suppressing investment.