The prospect of a rate increase in coming months took markets by surprise and pound sterling immediately jumped over 1 percent to US$1.336 and is now 8.6 percent higher than at the start of this year. However, it still remains 6.6 percent below its level before the June 2016 vote on Brexit.
The central bank of the United Kingdom has maintained its benchmark bank rate at 0.25 percent since August 2016 when it was slashed to a record low in the wake of Britain's surprise decision to leave the European Union (EU), commonly known as Brexit.
On top of the August rate cut - the bank's first since March 2009 during the global financial crises - the BOE also launched a package of stimulus measures that included the purchase of 10 billion pounds of corporate bonds and expanded its purchases of government bonds by 60 billion pounds to total of 435 billion to cushion the economy from the uncertainty that will accompany the country's adjustment to life outside the EU bloc.
The shift to a more hawkish tone by the BOE's nine-member monetary policy committee (MPC) reflects stronger-than-expected UK economic growth that is eroding "a fairly limited degree" of spare capacity faster than expected and will likely push inflation "above" 3.0 percent in October.
This compares with last month when MPC saw inflation peaking "around" 3 percent in October.
The BOE targets inflation of 2.0 percent and in August inflation rose to 2.9 percent from 2.6 percent in the previous two months.
Given the dampening impact on the economy from uncertainties during negotiations about Britain's future outside the EU, the BOE has accepted a temporary rise of inflation above its target and kept rates at a historic low to avoid economic slowdown.
But with the economy continuing to perform better than expected, the BOE is now preparing to reduce monetary stimulus to curb inflation and join other major central banks, such as the U.S. Federal Reserve and the Bank of Canada in reigning in years of ultra-easy monetary policy.
As in June and August, two MPC members - Ian McCafferty and Michael Saunders - again voted to immediately raise the bank rate by 25 basis points to 0.50 percent while the other seven thought the current rate was appropriate.
At its next meeting in November, the MPC will update its inflation and growth forecasts.
In August the BOE lowered its 2017 growth forecast to 1.7 percent from 1.9 percent forecast in May and the 2018 growth forecast to 1.6 percent from 1.7 percent. 2019 growth is seen at 1.7 percent.
Inflation in the third quarter of 2017 was seen at 2.7 percent, up from the May forecast of 2.6 percent, and then easing to 2.6 percent in Q3 2018 and 2.2 percent in Q3 2019.
The bank rate, as implied by market interest rates, was seen unchanged at 0.2 percent in the third quarter of this year, rising to 0.5 percent in the Q3 2018, up from the previous forecast of 0.3 percent, and then rising further to 0.6 percent in Q3 2019, up from 0.4 percent.
Although the U.K. economy only grew by 0.3 percent in the second quarter from the first quarter, the BOE noted the unemployment rate in the three months to July fell further to 4.3 percent to the lowest level in over 40 years and employment is expected to remain strong as demand continues to grow in excess of supply.
The Bank of England released the following statement:
"The Bank of England’s Monetary Policy Committee (MPC) sets monetary policy to meet the 2% inflation target, and in a way that helps to sustain growth and employment. At its meeting ending on 13 September 2017, the MPC voted by a majority of 7-2 to maintain Bank Rate at 0.25%. The Committee voted unanimously to maintain the stock of sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, at £10 billion. The Committee voted unanimously to maintain the stock of UK government bond purchases, financed by the issuance of central bank reserves, at £435 billion.
The MPC set out its most recent assessment of the outlook for inflation and activity in the August Inflation Report. That assessment depended importantly on three main judgments: that the lower level of sterling continues to boost consumer prices broadly as projected, and without adverse consequences for inflation expectations further ahead; that regular pay growth remains modest in the near term but picks up over the forecast period; and that subdued household spending growth is largely balanced by a pickup in other components of demand.
Since the August Report, the relatively limited news on activity points, if anything, to a slightly stronger picture than anticipated. GDP rose by 0.3% in the second quarter, as expected in the MPC’s August projections, although initial estimates of private final demand were softer than anticipated. The unemployment rate has continued to decline, to 4.3%, its lowest in over 40 years and a little lower than forecast in August. Survey indicators are consistent with continued strength in employment growth. Evidence continues to accumulate that the rate of potential supply growth has slowed in recent years. Overall, the latest indicators are consistent with UK demand growing a little in excess of this diminished rate of potential supply growth, and the continued erosion of what is now a fairly limited degree of spare capacity. Underlying pay growth has shown some signs of recovery, albeit remaining modest.
The sterling exchange rate has been volatile and the price of oil has increased. Headline and core CPI inflation in August were slightly higher than anticipated. Twelve-month CPI inflation rose to 2.9% and is now expected to rise to above 3% in October.
The circumstances since the referendum on EU membership, and the accompanying depreciation of sterling, have been exceptional. 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. The MPC’s remit specifies that, in such exceptional circumstances, the Committee must balance any trade-off between the speed at which it intends to return inflation sustainably to the target and the support that monetary policy provides to jobs and activity. Recent developments suggest that remaining spare capacity in the economy is being absorbed a little more rapidly than expected at the time of the August Report, and that inflation remains likely to overshoot the 2% target over the next three years.
All MPC members continue to judge that, if the economy follows a path broadly consistent with the August Inflation Report central projection, then monetary policy could need to be tightened by a somewhat greater extent over the forecast period than current market expectations. A majority of MPC members judge that, if the economy continues to follow a path consistent with the prospect of a continued erosion of slack and a gradual rise in underlying inflationary pressure then, with the further lessening in the trade-off that this would imply, some withdrawal of monetary stimulus is likely to be appropriate over the coming months in order to return inflation sustainably to target. All members agree that any prospective increases in Bank Rate would be expected to be at a gradual pace and to a limited extent.
At this month’s meeting, seven members thought that the current policy stance remained appropriate to balance the demands of the MPC’s remit. Two members considered it appropriate to increase Bank Rate by 25 basis points. The Committee will undertake a full assessment of recent developments in the context of its November Inflation Report and accompanying economic projections.
There remain considerable risks to the outlook, which include the response of households, businesses and financial markets to developments related to the process of EU withdrawal. The MPC will respond to these developments as they occur insofar as they affect the behaviour of households and businesses, and the outlook for inflation. The Committee will continue to monitor closely the incoming evidence on these and other developments, and stands ready to respond to changes in the economic outlook as they unfold to ensure a sustainable return of inflation to the 2% target."
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