The weaker-than-expected performance of the economy in early 2018 has forced the Bank of England to put back plans for an increase in interest rates until later this year.
Although the Bank believes the soft patch in growth will prove temporary, seven of the nine members of its monetary policy committee (MPC) adopted a wait-and-see approach to raising official borrowing costs on Thursday, voting to keep them at 0.5%.
Mark Carney, the Bank’s governor, said a rate rise was more likely than not before the end of the year, provided the economy rebounded as expected from a first quarter in which it grew by 0.1% – the slowest pace in more than five years.
Two committee members, Michael Saunders and Ian McCafferty, said rising pay caused by falling unemployment required an immediate increase in interest rates.
One of Gordon Brown’s first moves as chancellor in 1997 was to hand control of interest rates to an independent Bank of England. Previously the cost of borrowing had been decided between the chancellor and the governor of the Bank.
Rates are set by the Bank’s monetary policy committee (MPC), which consists of nine members – the Bank of England governor, the three deputy governors for monetary policy, financial stability and markets and banking, the chief economist and four external members appointed directly by the chancellor.
The four external members are appointed to bring thinking and expertise from outside the Bank to the meetings. A Treasury representative also attends the meetings and can discuss policy issues but is not allowed to vote.
The committee meets monthly to discuss whether to cut, raise or leave interest rates unchanged, as well as other measures such as quantitative easing. The decisions are made after a vote by each committee member; in the event of a tie, the governor has the casting vote.
Minutes of the meetings are published after the rates decision has been announced.
The Bank’s decision – outlined in its quarterly inflation report – will come as no surprise to the City, which expected Threadneedle Street to ditch plans for tighter policy this month in the light of weak growth, a faster-than-expected fall in inflation and evidence that consumers were cutting back on spending.
Even so, news that a rate increase was being delayed resulted in the pound falling against the dollar to below $1.35, its lowest level in four months.
The minutes of this week’s MPC meeting showed rate rises are still being planned in order to meet the government’s 2% inflation target, but the language was notably softer than in February when the Bank said policy would probably need to be tightened earlier and to a greater extent than the markets were expecting.
Three months ago, the Bank had been pencilling in growth of 0.4% in the first quarter and 1.8% for 2018 as a whole. The near-stalling of the economy has led the MPC to cut its annual growth forecast to 1.4% for this year.
But Threadneedle Street’s belief that little fundamental has changed since February and that the economy actually grew more strongly than 0.1% has kept alive speculation that a quarter-point increase in borrowing costs is possible when the next inflation report is released in August. Carney said that if the economy performed as the Bank expected, a “modest tightening” of policy would be warranted.
The Bank believes the economy has the potential to grow at about 1.5% a year but that demand will slightly exceed that limit in the coming years in the absence of a gentle increase in interest rates. The financial markets are expecting three quarter-point increases over the next three years.
As in February, the MPC pointed to the fall in unemployment to its lowest level since the mid-1970s as the reason why rates would eventually have to rise. Wage pressures are expected to build as employers struggle to recruit and retain staff.
Bank economists think the first-quarter growth figure was distorted by unusually cold weather and will eventually be revised up to 0.3%. “Survey indicators, and evidence from the Bank’s (regional) agents, suggested that growth had been somewhat stronger in the first quarter than implied by the preliminary estimate,” the MPC minutes said.
Even so, the seven members of the MPC who voted for no change said they wanted confirmation that the economy had merely been going through a soft patch before voting for higher rates.
“Given the recent weakness in consumer credit and the housing market, there was somewhat greater than usual uncertainty about the near-term momentum in consumer spending and the extent to which households would adjust their spending and saving to the past fall in their real incomes,” the minutes said.
Frances O’Grady, the general secretary of trade union body the TUC, said: “It’s the right decision not to raise interest rates. You don’t kick the economy when it’s down. Now the government must get our ailing economy back on its feet, delivering decent jobs and a real rise in wages.”
