The Bank of England on Thursday voted to keep interest rates on hold at 0.75 per cent as its Monetary Policy Committee decided the improvement in business sentiment since the general election made an immediate cut unnecessary.
But on the eve of Brexit, the central bank dealt a blow to Boris Johnson’s government by further downgrading its view of the underlying prospects for the economy to their lowest level since the second world war.
The MPC estimated Britain’s economy would be able to grow at only an average rate of 1.1 per cent over the next three years without sparking damaging inflationary pressure. This is less than half chancellor Sajid Javid’s ambition of boosting the growth rate towards 2.8 per cent.
Longer-term difficulties for the UK economy as it transitions away from the EU, however, did not dominate the MPC’s immediate decision on interest rates.
The nine-member committee voted seven to two in favour of holding rates at 0.75 per cent, which it expected would keep inflation rising gently up to its 2 per cent target within three years.
The majority of MPC members thought a stabilisation of the global economy since December, a reduction in global trade tensions and better UK survey data of households and companies “supported the forecast of a near-term recovery in growth”.
Shortly before the decision was announced, sterling spiked higher, prompting the BoE to refer the trading patterns to the Financial Conduct Authority to investigate whether any were suspicious. With the price move coming about 10 seconds before the MPC announcement, the BoE wanted to be sure there was no leak of information.
The MPC’s view that the economy was picking up in the near term came despite the committee — whose members had also voted seven to two to hold rates in December — remaining uncertain about whether it would avoid recession in the months ahead.
The BoE estimated there was a 38 per cent chance the economy is currently in recession, with output lower in the first quarter than a year earlier.
“The committee would monitor closely the extent to which these early indications of an improved outlook were sustained and followed through to the hard data on domestic activity in coming months,” said the minutes of the MPC meeting.
Mark Carney, BoE governor, said that following the election, there was still much uncertainty. “These are still early days,” he added at his last MPC meeting before stepping down. “It’s less of the case, ‘so far so good’, than ‘so far, good enough’.”
The two dissenting MPC members — Jonathan Haskel and Michael Saunders — argued that survey data were often unreliable and there were still significant dangers from the global economy and Brexit.
“Risk management considerations favoured a prompt response to downside risks at present in order to ensure a sustained return of inflation to the target,” they wrote in the MPC minutes.
One other reason for caution among the majority of MPC members was that they were unable yet to factor into forecasts the additional public spending on infrastructure that Mr Javid has earmarked for his March Budget.
With weakness in demand and supply, the MPC dropped language used since 2014 that it expected “limited and gradual” interest rates rises over coming years.
Instead of this, the MPC said merely that if the economy performed as well as it forecast, “some modest tightening of policy may be needed to maintain inflation sustainably at target”.
The largest changes to the BoE’s forecasts were to downgrade the longer-term prospects for the economy. If the MPC’s fears are realised, it will be much harder for the government to raise living standards, keep the public finances healthy and improve the performance of weaker regions.
Part of the downgrade came from MPC members judging that the poor UK productivity performance of the past decade was likely to continue, leaving the potential growth rate of the economy averaging just 1.1 per cent per annum over the next three years, although it would rise from about 1 per cent in 2020 to about 1.5 per cent in 2023.
This average estimate of sustainable growth for the next three years has halved since before the 2016 Brexit referendum. Then, BoE officials thought the economy could sustain a growth rate of 2.2 per cent, although the central bank cautioned that not all of the latest downgrade was as a result of the vote to leave the EU.
Nevertheless, the BoE squarely blamed the distraction of Brexit for part of this weakness, curbing business investment and forcing companies to plan for an EU departure that “is likely to have diverted time and effort away from other activities”.
The MPC also made a subtle change to its assumptions for Brexit, pencilling in a smooth move towards a free trade agreement between the UK and the EU at the end of 2020.
The pound climbed following the MPC decision to hold interest rates, trading 0.4 per cent higher at $1.3080 against the dollar. UK government bonds fell, pushing the 10-year gilt yield 0.02 percentage points higher to 0.52 per cent.
Ahead of the decision, markets had been pricing in close to a 50 per cent chance of a rate cut, meaning many investors were positioned for looser monetary policy.
Additional reporting by Tommy Stubbington in London
Source: Economy - ft.com
