Interest Rates Become Interesting Again

16 June 2017

Interest Rates Become Interesting Again

Political uncertainty and economic data points to lower rates…

In times of economic uncertainty the standard play for monetary authorities is usually to support economic activity with loose monetary policy. We’ve had a few unexpectedly weak data points in recent weeks (including retail sales, wage growth and business confidence) and, when considered alongside the obvious problems facing the UK following Theresa May’s disastrous ‘snap election’ all the signs pointed to a continuation of the Bank of England’s accommodative interest rate stance. Though the Monetary Policy Committee (MPC) broke from unanimity in its decision to hold rates at 0.25% back in March the one dissenting voice came from US economist Kristen Forbes who is due to step down at the end of June, and as we have previously commented this may well have been no more than a departing protest vote reflecting a series of readings showing that inflation is above-target.

…but inflation says hike!

Thursday’s meeting saw MPC members Michael Saunders and Ian McCafferty join Kristin Forbes in calling for a rate rise, and though lift-off has been averted for the time being the five-to-three vote represents the biggest call for monetary tightening since 2011. Markets were clearly not expecting such a shift in opinion from officials, and the change in sentiment resulted in the biggest sell-off in the more domestically focussed FTSE 250 so far this year. Inflation is clearly at the forefront of policy-makers’ minds at the moment, and with consumer prices now rising at 2.9% per year - the highest level since June 2013 and considerably higher than wage growth – the UK consumer is now being squeezed.

Can consumers weather the storm?

Markets, including the FTSE 250, are still within touching distance of all-time highs, but the resilience of unexpectedly strong consumer spending that has kept the UK economy firing on all cylinders since Brexit is now being called in to question. In the Bank of England’s own words, “Monetary policy cannot prevent either the necessary real adjustment as the United Kingdom moves towards its new international trading arrangements or the weaker real income growth that is likely to accompany that adjustment over the next few years”

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