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Bank eases foot off interest rate accelerator

As pressures grow on the Bank of England to act on interest rates, the Bank’s Greater London Deputy Agent Lai Wah Co explains how the Monetary Policy Committee is easing the accelerator, but not putting on the brakes.

Lai Wah Co

March 2018

The Bank of England has been providing significant monetary support to the UK economy for more than a decade. But we’ve seen inflation rise above the Bank’s 2% target since the big fall in sterling following the Brexit vote, which pushed up both import costs and shop prices.

At the same time, the weaker pound has helped increase the competitiveness of some UK exports, when demand is being supported by strong growth in Europe, the United States and other countries. This should encourage exporters to invest and recruit more staff.

We have seen some evidence of this happening, but the pick-up in investment has been weaker than expected based on past experience. Uncertainty surrounding Brexit has dampened investment plans for some companies.

Over the past year, prices have been rising faster than wages, squeezing the spending power of households. The good news is that we think that squeeze is likely to start easing.

See also: Bank explains move on interest rates 

The unemployment rate is now at its lowest level since 1975. And there are a lot of job vacancies. Our London business contacts tell us that it is difficult to recruit and retain workers, which is leading some to offer higher wages.

And that can also lead to inflation, as businesses look to recoup their increased costs through higher prices.

Given these inflationary pressures, the Bank is thinking carefully about whether the level of support we’re providing to the economy is appropriate. If we set interest rates too low, the economy will grow too fast, keeping inflation above our 2% target. But if we set interest rates too high or raise them too rapidly then growth will be too slow, and inflation could fall below target.

Put another way, we are trying to keep the economy growing at its ‘speed limit’.

We think the current annual growth speed limit of the UK economy is around 1.5% but our latest forecast suggests we are on track to grow a bit faster than that.

So, we think the economy needs a little less support from us.

Last November we raised the official interest rate, known as Bank Rate, from 0.25% to 0.5%.

Although the Bank’s Monetary Policy Committee voted to keep rates at 0.5% this month, it also indicated that, if the economy performs as expected, rate rises would be necessary to prevent the economy from overheating.

But the committee also stressed that any further rises are likely to be at a gradual pace and to a limited extent. So, interest rates are likely to remain substantially lower than a decade ago.

This isn’t a case of putting the brakes on; we’re just easing the foot off the accelerator a little.

And we’re doing that because, 10 years on from the financial crisis, the economy is finally returning to normal. That’s got to be welcome news for households and businesses.

Lai Wah Co is Deputy Agent for Greater London. You can read the Bank’s latest Inflation Report in full or the Agents’ latest Summary of Business Conditions

Follow the Bank of England in Twitter @BoELondon 

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