The pound fell sharply against major currencies today after the Bank of England cut its forecast for UK growth – but tried to balance that by leaving the door open to an interest rate hike in the not-too-distant future.
Sterling fell by as much as two cents against the euro to hit its lowest level since the start of November, at €1.1059, after the Bank left its key interest rate unchanged. Against the US dollar it hit lows of $1.3113.
The MPC voted by six votes to two to leave bank rate untouched at its historically low level of 0.25 per cent, with Ian McCafferty and Michael Saunders dissenting. The Bank's chief economist, Andy Haldane, did not vote for a hike, after previous rhetoric suggesting he might take the plunge.
The timing of a rate hike has been complicated by the weakness in growth in the British economy.
The Bank's forecast downgrade for the UK economy came as it said reduced consumer spending will drag GDP growth to 1.7 per cent this year, down from a previous forecast of 1.9 per cent.
Bank governor Mark Carney said: “We're going through a sluggish period in the economy”. Falling household real income is dragging on spending, despite updated forecasts that unemployment will fall to a four-decade low of 4.4 per cent.
Consumer spending will “remain subdued throughout the next three years”, the MPC said, dragging on the economy.
While a gradual pick-up in investment will eventually offset that fall, Carney noted it expects the level of investment in 2020 to be 20 per cent lower than the Bank's pre-referendum forecasts.
Peter Dixon, chief UK economist at Commerzbank, said: "The outlook presented by the BoE today was not very different to prior expectations, although perhaps governor Carney’s opening comments highlighted the economic risks posed by Brexit more than has hitherto been the case."
The MPC's updated forecasts come after second-quarter growth figures showed a limp expansion of only 0.3 per cent, after an even weaker first quarter.
Bank governor Mark Carney said the UK is "in the teeth of it right now", but added that the Bank expected growth to accelerate if a "smooth" Brexit transition is achieved.
However, despite the downgrade to its growth outlook, the rate-setting monetary policy committee (MPC) also gave a more hawkish signal that rates could rise faster than markets are currently pricing.
The Bank’s central forecasts now imply an interest rate hike by the third quarter of 2018, and a second by the end of the forecast period in the third quarter of 2020, but governor Mark Carney said that would be "insufficient relative to what is required" if the economy picks up as expected.
The MPC's minutes added: “Monetary policy could need to be tightened by a somewhat greater extent over the forecast period than the path implied by the yield curve underlying the August projections.”
The Bank also confirmed it will withdraw the Term Funding Scheme (TFS), part of the monetary policy stimulus introduced last year in the aftermath of the Brexit vote to boost bank lending. The closure of the scheme will come in February 2018, the MPC announced, in line with its previous plans to give six months’ notice.
|Still awaiting domestic inflation|
Inflation is expected to peak at around three per cent in October, despite the recent fall in inflation in June to 2.6 per cent. The Bank still ascribed the overshoot of its two per cent target “entirely” to the effects of the weaker pound.
The MPC again noted the lack of domestically generated inflation, with Carney saying domestic pressures are "not yet at rates that have historically been consistent with inflation being at the two per cent target". However, he added, "we do expect those to build."
A big part of that is the continued weakness in wage growth, which has failed to pick up despite lower and lower unemployment.
The Bank still predicts there will be some slack in the labour market, despite the low headline unemployment figure, as firms hold back from pushing workers to their full capacity.
That is expected to lower the upward pressure on wages this year, while even by 2019 wage growth of 3.25 per cent will remain a percentage point below the pre-financial crisis average.
The Bank also left in place its other stimulus measures: the stock of government bonds bought under the quantitative easing will remain at £435bn, while the Bank’s corporate bond pile will stay at £10bn. This was unchanged from the totals announced as part of the emergency stimulus a year ago.