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Is the Bank of England’s impending rate hike too late?
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Is the Bank of England’s impending rate hike too late?

Joshua Roberts Weekly bulletin July 2018

All eyes will be turned towards the Bank of England this week, as it prepares to raise interest rates above 0.5% for the first time in nearly a decade at midday on Thursday. Admittedly, Mark Carney, the Bank’s governor, has spent much of the last five years hinting that this increase was imminent only to subsequently pirouette away from the decision. Nevertheless, there is good reason to believe that this time really is different, and the Monetary Policy Committee (MPC) will finally follow through at its meeting on Thursday.

First, there is the fact that even with Mr Carney’s track record as the ‘unreliable boyfriend’ of monetary policy, this would be an extremely late stage to ask for a rain check. After three months in which a range of MPC members have consistently hinted at a rate rise, traders currently assign a 90% probability to the event. For it not to materialise would now be a significant shock, triggering a bout of turbulence in the interest rate markets that would quickly spread through to UK equities and the value of the pound. Given the febrile atmosphere in British politics at present, a further wave of volatility here is hardly needed – and no committee member will relish the prospect of being held responsible for one.

That is not to say that the case for a rate hike lacks a macroeconomic basis. The Bank has worried for some time that UK productivity, measured in terms of the goods produced or services provided per hour, will struggle to grow faster than 1.5% per year. If this is true, then any GDP growth above that level is likely to push up inflation. With survey data suggesting that GDP is currently growing at around 1.6% per year, the argument goes that pressure on prices is sure to emerge soon. Any Brexit-induced disruption to imports or supply chains could exacerbate this pressure, causing inflation to climb from its already-above-target level of 2.4%. Raising rates would help prevent the economy from overheating in this manner.

The problem is that focussing only on the headline numbers means ignoring several important aspects of an economy that may be significantly more vulnerable to rising rates than it has been for some time. One does not need to look to the obvious economic uncertainty associated with Brexit to find evidence of these. Most prominent is the pressure on high street retailers and restaurant chains resulting from online (typically overseas) competition and reduced consumer spending. Barely a month seems to go by without a well-known company announcing that it is closing multiple stores or entering administration. It hardly takes an economist to see that rising borrowing costs are unlikely to improve this situation, or to work out the likely impact on unemployment and wages.

Less widely reported, but much more alarming, is the level of debt currently being taken on by UK households. A report released last week by the Office for National Statistics showed that the average British household spent £900 more than it earned in 2017. This marked the first year since 1988 in which the average household was a net borrower – and the total deficit, of £25 billion, dwarfs the 1988 figure of £0.3 billion. It was also the first year since 1987 where households accumulated more debt than assets. Predictably, the poorest households were the worst hit, with those in the bottom decile for earnings spending two and a half times their disposable income. The result is that the amount of money owed in short term loans is now back above its pre-crisis level.

It would be wrong to suggest that the Bank is ignoring this. Indeed, Jon Cunliffe, one of the deputy governors, used an interview with BBC radio last month to highlight household debt as one of his top concerns should the country fall into recession. But the issue’s absence from subsequent statements has been conspicuous, not least because as recently as last year it was cited along with the economic uncertainty caused by Brexit as one of the key reasons for keeping rates on hold. We are now in a situation where the latter problem is still – to put it politely – some way short of resolution, while the former has worsened. And yet whereas last year was too soon for anything further than a reversal of the post-referendum rate cut, now it is apparently time to start the tightening cycle proper.

A cynic might say that the coming hike has little to do with the macroeconomic case outlined above. It could in fact be the action of policy makers who fear an impending recession and have finally woken up to the fact that, were interest rates to be at their current levels when this struck, their options for providing a monetary stimulus would be unenviably limited. The unreliable boyfriend should have plucked up the courage to hike rates some time ago. By now, it may well be too late in the game to create sufficient ‘dry powder’ to deal with the storm clouds ahead.

Upcoming economic releases

While Thursday’s MPC meeting is likely to overshadow other UK data this week, other key releases are numerous, including:

Tuesday

  • Eurozone unemployment rate for June (expected at 8.3% down from 8.4% last month)
  • Eurozone advance figures for core CPI growth in July (expected at 1.0% YoY, up from 0.9% last month)
  • Eurozone advance figures for Q2 GDP growth (expected at 2.2% YoY, down from 2.5% last quarter)

Wednesday

  • US FOMC rate decision (no change expected from current range of [1.75-2.00]%)
  • Eurozone final figure for July Manufacturing PMI (expected at 55.1 – no change)
  • UK Manufacturing PMI for July (expected at 54.2, down from 54.4 last month)
  • US final figure for July Manufacturing PMI (expected at 55.5 – no change)

Thursday

  • UK Construction PMI for July (expected at 52.8, down from 53.1 last month)

Friday

  • Eurozone final figure for July Services PMI (expected at 54.4 – no change)
  • Eurozone final figure for July Composite PMI (expected at 54.3 – no change)
  • UK Services PMI for July (expected at 54.7, down from 55.1 last month)
  • UK Composite PMI for July (expected at 54.9, down from 55.2 last month)
  • US change in Nonfarm Payrolls for July (expected at 193k, down from 213k last month)
  • US Unemployment Rate for July (expected at 3.9% down from 4.0% last month)
  • US Average Hourly Earnings growth for July (expected at 2.7% YoY, same as last month)
 

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