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UK CommentBank of England hikes in line with market expectations

  1. MPC with unanimous hike
  2. Outlook broadly unchanged – conditioning path implies two more hikes by the end of 2020
  3. We believe today’s hike was the last one for the next tow to three years
MPC delivers unanimous hike
The Monetary Policy Committee (MPC) of the Bank of England (BoE) decided to raise the policy rate by 25 basis points to 0.75 percent at today’s meeting. The MPC also decided to keep the QE programme unchanged. The decisions were unanimous. The decision to raise the policy rate was in line with market expectations, while we had expected the policy rate to be on hold until November, although acknowledging the likelihood of a hike today had increased. According to the BoE, the near-term outlook had evolved broadly in line with the MPC’s expectations. Although the global outlook was a little softer, recent data appeared to confirm that the dip in UK output in the first quarter had been temporary, with momentum recovering in the second quarter. The MPC’s assessment was that the labour market had continued to tighten and unit labour cost growth had firmed. The BoE still expects annual GDP growth of around 1¾ percent ahead, and inflation is expected to stay a little above 2 percent before returning to target in 2021. On the margin, the August inflation forecast was slightly higher than the one in May as a result of a weaker pound.
Neutral interest rate for the UK lower than before
The BoE today also offered its renewed assessment of the neutral policy rate for the UK. The BoE said that the longer-term neutral real rate probably had fallen some 2 percentage points since the 1990s, and now believed it to be somewhere between 0 and 1 percent. The neutral nominal rate would therefore be somewhere between 2 and 3 percent (just adding the inflation target). However, the BoE believed that the shorter-term neutral rate was even lower than the longer-term rate, implying that the nominal rate currently needed to balance the economy was lower than 2-3 percent. For monetary policy to be expansionary, the policy rate would have to be set lower than the short-term neutral rate. Ahead, the BoE expected the short-term neutral rate to rise toward the longer-term rate, but said that interest rates are expected to remain low by historical standards for some time to come.
We believe today’s hike was the last one for the next two to three years
Regarding the policy rate outlook, the MPC said that should the economy continue to develop broadly in line with the August projections, an ongoing tightening of monetary policy would be warranted over the forecast period to return inflation sustainably to the 2 percent target. The conditioning path (based on market rates) for the Bank of England forecast implies that the policy rate will be hiked two times more by the end of 2020, with the next hike expected in Q3 next year. While the BoE might have surprised markets today with a unanimous decision, the language used by the MPC was rather moderate and the forecast was largely the same as in May. So market expectations should not be very much affected, we believe. Our expectation for UK growth and interest rates is a little less optimistic than that of the BoE and the market. Ahead, we believe a cooling global economy and a hard Brexit (we expect a Canada-type solution) will weigh further on the UK economy, and our expectations for GDP growth and inflation are weaker than those of the BoE and consensus. We believe that the hike delivered by the BoE today was the last one for the next two to three years.

Disclaimer

Kari Due-Andresen

Chief Economist Norway

Norway and UK

kadu01@handelsbanken.no

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