With the UK economy struggling, economic and political uncertainty magnified by the election result, and earnings growth very weak, a compelling case can still be made for the Bank of England to hold off from any interest rate hike.
By Howard Archer, Chief Economic Advisor to the EY ITEM Club:
The Bank of England's decision to keep interest rates at 0.25% followed a surprisingly close 5-3 vote (compared to 7-1 at the May meeting).
Clearly, an above-expected rise in consumer price inflation to 2.9% in May and a 2.5% fall in sterling since the May Quarterly Inflation report proved too trying for the inflation overshoot tolerance of two MPC members. A further tightening in the labour market also seems to be a factor.
Despite the closeness of the June vote, it is far from certain that interest rates will rise in the near term. There is the potential for the balance of views to alter, with the imminent changes in the MPC's membership. Kristin Forbes who has been a strong advocate of raising interest rates is now leaving the MPC, while another member is due to appointed as the committee is currently one short.
With the UK economy struggling, economic and political uncertainty magnified by the election result and earnings growth remaining weak, a compelling case can still be made for the Bank of England to hold off from any interest rate hikes – not just now but for some time to come. The UK economy looks to be finding growth hard to come by again in the second quarter following GDP growth of just 0.2% quarter-on-quarter in the first quarter. Furthermore, a deepening squeeze on consumer purchasing power and increased economic and political uncertainties could further hamper growth over the coming months.
Furthermore, there are inflationary developments that facilitate the Bank of England tolerating the overshoot. Oil prices have softened overall recently, pay growth is extremely weak and households' inflation expectations have essentially stabilised. Evidence of some 'easing back' of inflationary pressures further down the price chain came from the annual increase in producer input prices, which moderated to 11.6% in May from 15.6% in April and a peak of 19.9% in January.
Despite the closeness of the June MPC vote, there still looks to be a very real possibility that the Bank of England will hold off from raising interest rates in 2017. A tightening in 2018 is also far from certain given the cloudy economic and political outlook.