Bank of England signals markets to expect earlier interest rate hike to fight inflation

Jasper Jolly
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Bank Of England Inflation Report Press Conference
Governor Mark Carney was obliged to write a letter to the chancellor explaining the one percentage point overshoot of inflation (Source: Getty)

The Bank of England today set itself up for a faster pace of interest rate rises this year, saying that it wants to tighten monetary policy to fight rising inflationary pressures.

The Bank's monetary policy committee (MPC) voted unanimously to keep interest rates on hold, with bank rate at 0.5 per cent, but nevertheless gave a hawkish signal to markets in spite of equity market volatility earlier this week.

It also raised the growth forecast for the UK economy to 1.8 per cent this year, revised up from the previous forecast of 1.6 per cent made in November.

Business investment was reduced by up to four per cent in the year after the Brexit vote, the Bank estimated, but stronger world growth made up for the uncertainty hit in its predictions. The Bank now estimates global GDP will grow by four per cent this year, pushing up UK growth.

The MPC, led by Bank governor Mark Carney, said monetary policy will “need to be tightened somewhat earlier and by a somewhat greater extent over the forecast period than anticipated” at the previous forecast in November, if the economy continues as it predicts, according to minutes published today from its latest meeting.

Read more: How will Mark Carney respond to the FTSE 100 sell-off?

The Bank's previous forecasts, based on market interest rates, pointed to a hike at the November 2018 meeting, a year after the last November 2017 hike; a “somewhat earlier” move would lay the path for an increase in bank rate at its May meeting.

In November the Bank assumed only two hikes by the end of 2020, but today the Bank said even three interest rate rises over the next three years would leave “a small margin of excess demand” by early 2020.

To hammer home the point, the Bank said it will aim to reduce inflation over a “more conventional horizon” than before. Following the EU referendum in June 2016 the Bank had given itself more time to bring inflation down, fearing the necessary cut in interest rates would damage growth.

Yet since then the UK economy has remained fairly resilient, while consumer price index inflation hit a high of 3.1 per cent in November, prompting the Bank to consider returning to a more usual path.

Read more: Risk of a no deal Brexit isn't rising, says BoE's newest policymaker

In an open letter also published today to the chancellor, Philip Hammond, Carney said there was evidence of “building domestic inflationary pressures”, with real household income expected to rise faster, by 1.75 per cent, in 2018. The Bank's governor is obliged to write the letter if inflation moves more than one percentage point over its two per cent target.

While Carney views Brexit uncertainty as the main threat hanging over the UK's growth prospects, the MPC left little room for doubt that its tolerance for above-target inflation before raising rates again is “further diminished”.

Read more: Mark Carney expects "conscious recoupling" of the UK with global economy

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