In the months since the September policy meeting markets had largely reassessed the likelihood of the Bank of England (BoE) cutting interest rates to a fresh record low. This was largely due to the robustness of recent UK data, with the first post-referendum GDP figures surpassing expectations to show growth of 0.5% on the quarter. As a result, investors were unsurprised by the BoE’s decision to leave interest rates unchanged today, although that did not prevent the Pound from rallying sharply in response.
BoE Policymakers Surprisingly Hawkish with Suggestion of Interest Rate Rise
While the Monetary Policy Committee (MPC) voted unanimously to leave interest rates unchanged, in line with market expectations, the tone of the meeting minutes proved to be rather more hawkish in tone. Rather than simply emphasising a willingness to lower rates if the economy shows signs of weakening, the minutes instead stated that:
‘Monetary policy can respond, in either direction, to changes to the economic outlook as they unfold to ensure a sustainable return of inflation to the 2% target.’
This was a particularly notable change, given the dovishness of the September minutes, suggesting that the next move could ultimately be up rather than down. Naturally this encouraged investors to pile back into the Pound, with many economists consequently dropping their calls for interest rates to fall to 0.10% in February.
Policymakers appear to have been encouraged by the relatively robust nature of post-referendum UK data, with this morning’s October Services PMI offering another strong showing. As the domestic economy continues to grow in the wake of the Brexit vote the chances of further policy easing have seemed to diminish, a particularly positive prospect for the Pound.
Pound Exchange Rates Forecast to Remain Supported Despite Rising Inflationary Pressure
The November meeting was considered a particularly key date due to it coinciding with the release of the BoE’s latest quarterly Inflation Report. As policymakers revised up their growth forecasts for 2017 from 0.8% to 1.4% this seemed to offer a nod of confidence to the domestic economy’s ability to weather the persistent uncertainty of the coming months.
However, the implications of the report were not entirely positive, with the BoE also raising its inflation forecasts in response to the sharp weakening of Sterling. As stated in the report:
‘Although the exchange rate’s impact on inflation is temporary, it is likely to contribute significantly to inflation for several years. Inflation is therefore judged likely to rise sharply above the target over the next twelve months and still to exceed the MPC’s 2% target at the three-year forecast horizon, before falling back to the target beyond then.’
Given the relatively low pace of UK wage growth this suggests that real incomes are likely to be increasingly squeezed over the medium term. While the BoE has indicated that it is willing to allow an overshoot of the 2% target in favour of supporting economic growth this could nevertheless lead to its first interest rate hike since 2007. Even though an upwards move in interest rates seems unlikely to come any time soon the prospect is nevertheless likely to put something of a floor under Pound exchange rates and limit any further losses from Brexit-based uncertainty.