Bank of England raises UK interest rates

The Bank of England has done the inevitable and the expected by raising the interest rates. Léon Cornelissen, chief economist at Robeco, shares his view on whether this decision can be traced back to the Brexit vote or the Fed.

03.11.2017, 09:20 Uhr

Redaktion: elt

The Bank of England (BoE) has raised interest rates from 0.25% to 0.5% ratifying market expectations, with several members of the MPC having signaled for months a rate hike was coming. At first sight, a hike seems reasonable as inflation is currently running 3%. But this is a consequence of the earlier depreciation of the pound and most likely temporarily as there is little evidence of a wage-price-spiral. On the contrary, real earnings are currently being squeezed.

The economy has of course done better than expected after the Brexit vote. The hike could be justified as only taking back the easing after the Brexit vote, which – with the benefit of hindsight – turned out to be unnecessary ‘insurance’. But the UK economy is at the moment showing no signs of acceleration in contrast to the US and the Eurozone. Moreover, Brexit-negotiations are currently going nowhere, uncertainty will remain high for the foreseeable future and as a consequence declining business investment is a clear risk to future growth. Though, unemployment is at a 42 year low, but there is no sign of rising earnings growth, so little need for a preemptive strike.

It could of course be argued that the Brexit vote has resulted in a negative supply shock and given dismal productivity trends, the UK economy is with 0.4% quarterly growth already running ahead of potential. Estimates, however, of potential growth are notoriously difficult and tend to move over time and hardly make the case for an urgent need of a rate hike.

The BoE has declared that future increases will take place only “at a gradual pace and to a limited extent”. The rate hike can therefore be considered a “dovish” one.

The cautious maneuvering of the BoE could be considered as an echo of the attitude of the Fed, which on Wednesday signaled to stick to a gradual rate rise path. A December rate hike of 25 basis points is in my opinion a done deal, even given “soft” inflation. The most likely new chair Mr. Jerome Powell, an investment banker and lawyer, will likely follow the Yellen monetary policy line. Powell is the rational, low-risk choice for president Trump. It’s unlikely that a populist president would nominate a ‘hard money (wo)man’, theoretically in any case preferred by the Republican political establishment. Markets will probably consider the replacement of Yellen a non-event.

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