Some questions (and answers) about August's Super Thursday

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Not quite breaking news - but the Bank of England raised interest rates for the second time in a year to 0.75%. Here's what we said in response

"No surprises today with the MPC pressing ahead with the signaled rate rise, supported by their judgement that such a move was warranted given diminished spare capacity in the economy. While manufacturers are not unduly fazed by this small rate rise and the continued communication that future rises will be gradual, given the limited impact to industry, there are still risks. Indeed, like the Bank, manufacturers remain concerned about the UK’s future economic and trading relations with the EU. Clearly the Council meeting in October is an important one for MPC members’ diaries, with the outcomes going a long way to determine the timing of any future rate changes in the months ahead."
And in more detail....

 

What’s the Bank’s outlook for the UK economy?

In short, the outlook has shifted little from that outlined in the May Inflation Report. Headline GDP forecasts have been adjusted only very marginally (see chart) with their judgement holding that net trade and investment will provide some support to growth as consumer spending growth remains subdued.

The Inflation Report confirms their view last quarter that the weakness seen at the start of the year was temporary, with confidence and activity indicators recovering in the second quarter. Wage growth is outpacing inflation and unemployment is still at a historically low level. So essentially, conditions have moved with expectations and look set to remain on that path through 2018.

Obviously Brexit-related growth concerns were reiterated and the Bank is looking at a more mixed global picture, driven by the prospect of escalating trade tensions.

 BoE-Aug18

What’s behind the decision to increase interest rates?

It’s about the amount of slack in the economy. Yes growth has slowed, but potential supply growth has also fallen – a consequence of flat lining productivity and also, they note, slower growth in the working age population. So the economy doesn’t have to grow at pre-crisis rates before spare capacity is used up putting upward pressure on wages and prices.

The Committee believes that labour market indicators are heading in this direction of diminished spare capacity and gradual normalisation of monetary policy will keep price pressures in check. In line with their guidance in previous Inflation Reports, the MPC was clear that if their view on the prospects for the economy, as set out in their forecasts, are right then further rate hikes are coming, but these would be ‘gradual’ and ‘limited’.

 

Do EEF­_Economists agree?

Even if the vote wasn’t, we think the judgement on raising rates was a close call (see our preview blog). Arguments can be made on both sides and the Governor’s press conference comments pointing to the risks of waiting and waiting, and waiting some more, for absolute clarity around some of the possible growth hazards were pretty compelling.

Maybe we’re too pre-occupied by looming risks on the Brexit-front. Any perhaps we’re placing too much stall on the weak investment picture. But we’d have leaned towards the November Super Thursday to see if the all-important October European Council meeting give businesses the clarity needed to shore up confidence and investment.

 

Will manufacturers be worried about higher interest rates?

That said, we still think industry will take this rate rise in its stride. Our conversations with members in recent months haven’t flushed out any major concerns about rising interest rates. Indeed, when we asked manufacturers about how they view the risks from possible monetary policy changes at the start of the year, a third identified none and the main concern (expressed by just over three in ten) was the possible impact on domestic demand from an increase in Bank Rate. Only a small proportion were worried about borrowing costs - not surprising given that lending has been fairly subdued. The fact the rise was well signalled also eliminated the element of surprise.

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Author

Chief Economist

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20 Aug 2018

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