Interest rates have been hiked by the Bank of England for the first time in more than a decade, even as wages are growing weakly and the country faces the growing threat of a disastrous ‘no deal’ Brexit in March 2019.
The Bank’s nine-person Monetary Policy Committee voted by a margin of 7 to 2 to increase rates from their historic low of 0.25 per cent to 0.5 per cent.
It was the first rate hike from the central bank since July 2007, before the financial crisis and marks an important milestone in monetary policy.
The increase in the cost of borrowing will have an immediate impact on millions of households with variable rate mortgages and is expected to dampen economic activity over the coming months, even as the economy slows ahead of the UK’s scheduled departure from the EU in March 2019.
The hike had been almost universally expected by financial markets, after the MPC had previously signalled in August that it was likely to increase rates by the end of the year if the economy developed as expected.
The minutes of the MPC meeting cited signs of a pick up in “domestic inflationary pressures” and “persistent weakness in productivity growth” as the main justifications for its rate hike.
Inflation hit a five-year high of 3 per cent in September and the Bank expects its rate hike to help bring it back to slightly above the Bank’s official 2 per cent target by 2020.
However, the Bank said its forecasts are based on the assumption of a “smooth adjustment” of the UK economy to Brexit, something that has been thrown into increasing doubt by the failure of the Government to make any substantive progress in its Article 50 divorce negotiations with the European Union.
The OECD’s most recent forecasts, by comparison, are based on the assumption that Britain crashes out of the EU in 2019 without a trade deal or the hoped-for two-year transition period and that UK exporters to the EU face the sudden imposition of tariffs and other damaging trade barriers.
The Bank also reiterated that Brexit is already having a “noticeable impact on the economic outlook” in the form of considerably weaker business investment by firms in the face of future trade arrangements uncertainty.
It also stressed on Thursday that a lower rate of immigration from the EU into Britain over the coming years would likely damage the economy by hitting the supply of labour and reduce Britain’s potential growth ”speed limit”.
Financial markets will now speculate over the likely timing of the next rate hike by the Bank.
Before Thursday’s decision they were pricing in the next rise in the first quarter of 2019 and that for the hike after that not to occur until the third quarter of 2020.
The MPC stressed that Thusday’s rise - which effectively withdraws the 0.25 per cent cut in the immediate wake of the 2016 Brexit referendum - was “modest” and reiterated that future rises are expected to be “gradual and limited”.
Two MPC members - Sir Dave Ramsden and Sir Jon Cunliffe - voted to keep rates on hold at 0.25 per cent, disputing the majority view of the committee that average wage growth would pick up next year to 3 per cent.
Wages are currently rising at a rate of just 2.2 per cent, below the rates seen in 2015 and 2016 and despite years of projections from the Bank that this would rapidly rise to the pre-financial crisis growth rate of 4 per cent.
Some economists have warned the Bank is in danger of making a policy mistake by raising rates prematurely and that the move may have to reversed if the UK growth rate collapses ahead of Brexit.
After the last rate hike in 2007 the Bank was forced to cut rates again within five months as the global credit crunch intensified.
Given the unusually long duration since the last rate hike the Bank’s move is something of a gamble in terms of estimating the likely response of households to more expensive borrowing.
But the Bank does not expect the latest rate hike to have a dramatic impact on overall household spending, in part because only 40 per cent of mortgages by value are on floating rates, which change automatically with Bank rate.
At the time of the last rate hike in 2007 the floating rate mortgage share was closer to 60 per cent.
Fleshing out its essentially pessimistic view of the UK’s near-term economic prospects, the Bank said its latest estimate of the country’s rate of ‘potential supply growth’ - the rate of growth the economy can handle before running into dangerous inflationary pressure - over the next three years to be only about 1.5 per cent a year, or 0.4 per cent a quarter.
In the third quarter of 2017 UK GDP grew by 0.4 per cent, up from 0.3 per cent growth in the second quarter, but below the 0.6 per cent growth recorded in the eurozone.
The Bank expects GDP growth over 2017 to be 1.6 per cent, down slightly from its last forecast of 1.7 per cent. It sees growth next year and the year after of 1.6 per cent and 1.7 per cent respectively, unchanged from its previous forecast.
It now expects inflation to peak at slightly over 3 per cent this month, before gradually descending to the 2 per cent target by 2020.
