LONDON: Bank of England Governor Mark Carney is ready to raise interest rates from a position of economic weakness rather than strength. The fastest inflation in four years leaves the UK central bank preparing to hike next month for the first time in more than a decade, yet it’s not an accelerating economy fanning those price pressures. Instead, policy makers are being pushed to temper less friendly inflationary forces generated by weak productivity and Brexit.
The UK has fallen to the bottom of the Group of Seven growth rankings, but also of concern is the fact that it’s far less productive than international peers. For Carney, who’s warned that leaving the European Union could worsen the situation, that means a lower rate of growth is already enough to put a strain on resources, generating unwelcome domestic pressures. The International Monetary Fund was the latest to sound the alert on Tuesday when it said the UK has been the “notable exception” this year among advanced economies. It left its forecast for 2017 expansion at 1.7 per cent while raising estimates for the world, US and euro area. It’s a far cry from Janet Yellen’s build-up to the first Federal Reserve hike in 2015. While she signalled confidence in the economy, Carney has spoken of Brexit-related uncertainties delaying investment, reducing vital labour supply and creating a lower “speed limit.”
The supply capacity of the UK will expand at “only modest rates in coming years,” he said last month. While the weaker pound has boosted headline inflation, lower potential growth creates a risk of more persistent pressures as remaining spare capacity is absorbed faster. The BOE already sees inflation staying above its 2 per cent target for the next three years. “It’s sort of the opposite of the US story, where everyone’s saying ‘if we’re raising interest rates and getting on with QE unwinding it’s because it’s a sign of strength,”’ said Victoria Clarke, an economist at Investec in London. “In the UK it’s a very different background, and there seem to be some more complicated reasons — one of which is that they’re worried about a bit more of a persistent inflation problem.” There’s a near 90 per cent chance of a 25-basis-point increase on November 2, according to market pricing. That would reverse the stimulus after the 2016 Brexit referendum. Analysis by Bloomberg Intelligence shows that since 1997, the BOE has only raised rates when quarterly growth has been at least 0.5 per cent. While expansion this year has only been 0.3 per cent, for the BOE, reduced potential means that’s enough to erode spare capacity.
The BOE doesn’t publish a figure for potential economic growth, though policymaker Michael Saunders estimates it’s about 1.5 per cent, below the pre-crisis average of 2.5 per cent. The picture is in contrast to the one presented when the bank previously edged toward a hike. Former Chancellor of the Exchequer George Osborne said in early 2016 that higher rates would be “a sign of a stronger economy.”
