Look back on monetary policy and look ahead to fiscal policy

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Both monumental and marginal. That’s one verdict on this week’s MPC announcement to increase Bank Rate by 25 basis points – the first of its kind in more than a decade. As well as a policy change we also had the usual Inflation Report and forecast update from the Bank. Here’s a brief round-up of my seven takeaways. 

BoE-decision

1. Quarter point rise was a racing certainty

However finely balanced the judgement amongst individual members, past communication efforts signalling that a rise was in the pipeline meant that the only decision had to be a small hike.

The split on the committee was expected with two members being in the status quo minority.  

2. Tolerance gives way to too high for too long

The Inflation Report revealed virtually no change in the Bank’s outlook for growth and its components or inflation over the forecast period. In the short-term CPI inflation looks a bit stronger than previously forecast due to the higher oil price. The Committee’s forecasts were also consistent with the judgement in the August inflation report that the pass through of sterling’s depreciation had yet to run its course and would contribute to CPI remaining above target at the end of the forecast period.

The decision to raise rates seems less a change in judgement from the committee, but an issue of timing to ensure that the move was adequately signalled to markets.  

3. Impact on business conditions from this one decision will be minimal

Manufacturing indicators have been almost unanimously upbeat over the past couple of quarters, helped along by the global economy firing on ‘11 cylinders’, to quote the Governor. Recent discussions with manufacturers have not revealed mounting concern about an imminent rate rise. The view being that the overall impact on demand conditions would be negligible for most.  

And even for companies that might be affected by a change in borrowing costs, the move simply takes us back to levels in place last July.

4. Most likely next move is another up if economy evolves as expected.

The updated forecasts confirm that the likely path of interest rates over the next three years is for a couple of small increases. Without further action, and assuming that growth and the labour market evolve as the Bank expects, CPI inflation will be sitting at around 2.5% at the end of the Bank’s three year forecast horizon.

Markets don’t expect further rises to come in short order – it could be another year before the next one.         

5. There are definitely risks to growth and inflation outlook

The key judgements underpinning the Bank’s forecast update are:

  • Global growth remains strong
  • Investment and net trade support UK demand
  • Diminished slack and modest supply growth resting domestic inflationary pressures
  • Upward pressure from import and energy prices eases

 

The main risks we would identify with these judgements is the resilience of investment, particularly business investment in the coming years. Expectations of quarterly business investment growth of ¾% are quite a bit north of our projections for next year (though the Inflation Report acknowledges that even under this growth scenario investment levels will be well adrift of pre-referendum estimates).  

This is linked to the modest improvement expected in productivity over the next few years. Which will, in turn, support an acceleration in wage growth – though other factors, such as increased labour market churn – will also be in the mix. The Bank’s forecasts have been a bit off in this area in the past. Earnings growth has been expected to turn a corner for a few years, yet as so far disappointed.

For the inflation outlook however, it might be more significant to look at the gap between earnings growth and productivity improvements – if that continues to persist then upside risks to domestic inflationary pressures are real.

6. But cautious tone was struck by the MPC, especially around Brexit.

There were quite a few buts attached to the forecast outlook, with a cautionary tone being struck overall. Brexit is probably the most dominant one outlined at both the press conference and in the Inflation Report – it was stressed that monetary policy was nimble and next move could still be in either direction. The minutes of the meeting noted:

"There remained considerable risks to the outlook, which included the response of households, businesses and financial markets to developments related to the process of EU withdrawal. The Committee would continue to monitor closely the incoming evidence on these and other developments, including the impact of today’s increase in Bank Rate, and stood ready to respond to changes in the economic outlook as they unfolded to ensure a sustainable return of inflation to the 2% target."

 

7. Over to you now Chancellor

As the Bank takes it foot off the gas, attention turns to the November’s next big policy event – the Autumn Budget. Risks around productivity highlighted in the inflation report will resonate with the Chancellor, who will be acutely aware what no improvement in it will mean for high own policy decisions.

On Monday, we’ll be publishing our Budget submission, which sets out some recommendations on how the Chancellor might expend some firepower helping companies to propel more of their investment plans over the line and get productivity firing on a few more cylinders.

 

Author

Chief Economist

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