BoE to sit tight at June MPC meeting; Jury out on possible August interest rate hike

Bank of England

There can be little doubt that the Bank of England will keep interest rates unchanged at 0.50% on Thursday following the June Monetary Policy Committee (MPC) meeting, according to the EY ITEM Club, a leading UK economic forecasting group.

There is a great deal of doubt as to what the Bank of England will do with interest rates after the June MPC meeting. Indeed, the markets seem pretty split down the middle as to whether the Bank of England will lift interest rates to 0.75% at the August MPC meeting.

And, with interest rates down at 0.50%, the Bank of England would clearly likely to gradually normalise monetary policy given that inflation remains above target and the labour market looks relatively tight. However, current uncertainties, concerns about the economy’s strength and recent slowing earnings growth support the case for caution in raising interest rates.

Howard Archer, Chief Economic Advisor to the EY ITEM Club, comments: “The minutes of the May MPC meeting indicated that the committee believe that a gradual, limited tightening of monetary policy is warranted over the next two to three years given the perceived growth and inflation outlook. They also made clear that the MPC want to see how the economic data develops over the coming months to make sure that the first quarter slowdown in GDP growth was temporary, and to learn more about how the economy is evolving.

“The May minutes indicated that the MPC suspect GDP growth in the first quarter of 2018 was not as weak as the 0.1% q/q expansion currently reported by the Office for National Statistics (ONS) and will eventually be revised. The MPC also suspect that the first quarter slowdown was temporary and significantly weather-influenced. They also see GDP growth picking up to 0.4% q/q in the second quarter and return to a growth rate of around 1.75% over the medium term (which is modestly above the 1.5% growth speed limit that the Bank of England currently sees on the supply side). The May MPC minutes reported that “the conditions for steady growth had remained in place, the labour market had continued to be strong, and survey indicators had suggested that activity growth would pick up again in Q2”

He adds: “Most MPC members wanted to see clear evidence that the economy has picked up since the first quarter before voting for higher interest rates. In addition, UK economic data and surveys released since the May MPC meeting are highly unlikely to have convinced most MPC members to vote for an interest rate hike at the June meeting.

“Indeed, the latest UK economic news has been mixed enough to suggest that August could be too soon for most MPC members to be convinced that the economy is performing well enough to justify an interest rate hike.

“Firstly, the second release of UK GDP growth in the first quarter failed to revise up the reported growth rate of 0.1% q/q, Furthermore, the component breakdown of GDP growth in the first quarter was largely unappetising with consumer spending weakened and business investment and exports both falling.

“Meanwhile, the mixed latest news on the economy fails to provide decisive evidence of a marked pick-up in activity in the second quarter. In particular, a very poor set of April industrial production, construction output (reinforced by a marked drop in construction orders in the first quarter) and trade data fueled concerns about the economy’s performance at the start of the second quarter. Additionally, survey evidence from the purchasing managers for May on manufacturing and construction was lackluster overall.

“However, this has been countered by evidence that the consumer has been more active in the second quarter. Retail sales saw robust growth of 1.3% m/m in May after rebounding 1.8% m/m in April from a 1.1% m/m slump in March that was influenced by the severe weather. It needs to be kept in mind that retail sales were helped in May by much improved weather and were also boosted by the Royal Wedding. The MPC may want to see how retail sales develop over the next few months

“In addition, the purchasing managers reported a clear pick-up in services activity to a three-month high in May. However, the survey also showed tepid new services growth, reduced confidence and an increased squeeze on margins in the sector, thereby maintaining concerns about the outlook.”

Archer concludes: “Another factor that is likely to encourage MPC caution on raising interest rates is a recent relapse in earnings growth. The Bank of England has been keen to see earnings growth firm in order to support UK growth. The MPC has recently focused on regular earnings as this strips out the erratic impact of bonuses which can distort total earnings developments.

“After trending up from 2.3% in November itself to a peak of 3.0% in March, annual growth in regular earnings fell back to a five-month low of 2.5% in April. The Bank of England tends to focus more on the three-month annual growth rate in average earnings growth which irons out any erratic monthly moves. This eased back to 2.8% in the three months to April from 2.9% in the three months to March. The MPC may well want to see earnings growth resume an upward trend before raising interest rates.”

Consumer price inflation stable at 2.4% in May but higher producer prices points to near-term rise in inflation
“Stable consumer price inflation of 2.4% in May (the lowest rate since March 2017) also gives the Bank of England scope to hold off from raising interest rates in the near term.

“However, a year-on-year rise in May in producer input (to 9.2% from 5.6% in April) and output prices (to 2.9% from 2.5% in April) suggests that inflation could well increase over the summer months. This would likely reinforce the MPC’s belief that a modest tightening of monetary policy is warranted.”