Skip navigation Scroll to top
Scroll to top

In light of Brexit, was the Bank of England rate rise this week unwise?

03 August 2018

As expected, the Bank of England has raised the base rate by 0.25% to 0.75%, the highest since 2009. Whilst the vote at the Monetary Policy Committee (MPC) was unanimous, it has drawn criticism from several quarters. Notably a senior economist at the Institute of Directors suggested that they should have waited until November when the outcome of the Brexit negotiations should be clearer. Others have suggested that the rate cut following the Brexit vote was unnecessary and they should have raised rates sooner. The MPC retained their wording that further rate rises would likely be at a "gradual pace and to a limited extent". This was flagged so far in advance that the only surprise was that the vote was unanimous. The question as to if this was premature ahead of Brexit comes down to whether it is seen as a tightening move or just a reduction in stimulus when the economy no longer needs it.

While the initial reaction from markets was that the unanimous decision was slightly more aggressive and supported the pound, the tone of the press conference was softer and the pound sold off. Mark Carney stuck to the one rate rise per year for the next three years forecast. Carney does not expect to reduce bond buying until rates are at 1.5%, thus at current projections not until 2021. Questions were focused on Brexit and he was reluctant to be drawn into saying more than that there were a 'wide range of outcomes and monetary policy would react to circumstances'. Carney did say that the Prudential Regulatory Authority side of the bank was concentrating on making sure that banks would still be in a position to support the economy in all circumstances. 

There was a large section in the Quarterly Inflation Report on the trend equilibrium real interest rate (R* a new figure for the MPC). The equilibrium interest rate is the interest rate that if the economy starts from a position with no output gap and inflation at target, it would sustain output at potential and inflation at target. This is estimated to have fallen from 2.25-3.25% in the 90s to 0-1% over inflation. This is therefore consistent with interest rates in the very long term rising to 2-3%, well below the Bank of England's very long term historic rate of 5%. On these assumptions, the 0.5% rate prior to yesterday's meeting added a level of stimulus to the economy that, with low unemployment, real wage growth and inflation rate close to target, was unnecessary.   

The MPC had been expected to raise rates earlier in the year, but the slowdown in the economy in the first quarter made them err on the side of caution. The data indicates this was a temporary setback caused by bad weather and they now have confidence to move. The MPC has to react to the economy as they see it today, and currently predicts a slow path of further rises on the assumption that Brexit does not cause a major disruption. Given the wide range of possibilities and the ability to react to the change of circumstances, the move now is not unreasonable. However it is inevitable when looking at interest rates over the next two to three years, that the outcome of Brexit however unpredictable, is likely to have more impact than any long term trends. As far as investors are concerned, the Brexit impact is most likely to be largest in the currency and domestic bond markets. The UK equity market has a high proportion of companies with overseas earnings which may be impacted by currency moves, but in the short term, the wider investment markets are more sensitive to Trump's tweets on trade than widely predicted rate moves.

 

 

This communication is provided for information purposes only. The information presented herein provides a general update on market conditions and is not intended and should not be construed as an offer, invitation, solicitation or recommendation to buy or sell any specific investment or participate in any investment (or other) strategy. The subject of the communication is not a regulated investment. Past performance is not an indication of future performance and the value of investments and the income derived from them may fluctuate and you may not receive back the amount you originally invest. Although this document has been prepared on the basis of information we believe to be reliable, LGT Vestra LLP gives no representation or warranty in relation to the accuracy or completeness of the information presented herein. The information presented herein does not provide sufficient information on which to make an informed investment decision. No liability is accepted whatsoever by LGT Vestra LLP, employees and associated companies for any direct or consequential loss arising from this document.

LGT Vestra LLP is authorised and regulated by the Financial Conduct Authority (FCA).