Speech by Bank of England (BoE) Governor Mark Carney may increase expectation that the BoE is preparing the ground for a near-term interest rate hike, with a move as soon as November very much in play.
Mark Carney again warned that slack in the UK economy is diminishing and that this reduces the UK's tolerance of above-target inflation.
He also warned that the short-term impact of Brexit at least is likely to be inflationary.
Even if the BoE does hike interest rates from 0.25% to 0.50% sooner rather than later, it is highly likely that they will tread very carefully on further increases. Indeed, given that interest rates have not risen since 2007, the MPC may well sit tight for an extended period after an initial hike to see how consumers and businesses respond.
We also believe that the case for further BoE action after any initial hike will be limited by persistent slow UK growth, a steady easing back in consumer price inflation after a probable peak just above 3% in late-2017 (as the impact of sterling's past sharp drop fades) and Brexit uncertainties. We also believe that pay growth will firm only gradually over the coming months.
Carney himself stated that any interest rate increases are likely to gradual and limited.
Howard Archer, chief economic advisor to the EY ITEM Club comments:
"Governor Mark Carney's speech at the International Monetary Fund (IMF) maintained the view that the Bank of England (BoE) is paving the way for a hike in interest rates sooner rather than later with a move in November a very real possibility.
"In his speech, Mark Carney highlighted diminishing slack in the UK economy and observed that this reduces the BoE's tolerance of above-target inflation. A new factor that Mark Carney introduced in his speech was that "the case for a modest monetary tightening is reinforced by the possibility that global r*(equilibrium interest rate) may be rising, meaning that monetary policy has to move in order to stand still."
"Mark Carney also argued that the de-integration effects of Brexit are likely to be inflationary in the short-term at least. This is because trade ties with the EU may be impacted and it will take time to build new ones with other countries. A reduction in trade integration may have adverse implications for the supply of goods, services and labour at cheap rates. Integrated supply chains could also be impacted.
"In addition, Mark Carney warned that on the supply side of the economy, Brexit-related uncertainties are causing some companies to delay decisions about building capacity and entering new markets and warned that prolonged low investment will restrain growth in the capital stock and increases in productivity. He also noted that net migration has fallen by about 25% since the Brexit referendum. Consequently, he concluded "as a result of these factors and the general weakness in UK productivity growth since the global financial crisis, the supply capacity of the UK economy is likely to expand at only modest rates in coming years."
Carney's latest comments follow on from more hawkish September MPC minutes
"While the Monetary Policy Committee (MPC) voted 7-2 for unchanged interest rates at their September meeting, the minutes of the meeting had come across as markedly more hawkish.
"Admittedly, the BoE has previously discussed the likelihood of an interest rate hike which wasn't realised, but it is striking that there does seem to be a more concerted BoE effort to talk up an interest rate hike this time around and more unanimity within the MPC of the case for a near-term hike.
"These latest comments also follow remarks MPC member Gertjan Vlieghe made last Friday. It was intimated that the time for an interest rate hike is nearing – particularly notable as Gertjan Vlieghe had previously been seen as perhaps the most dovish MPC member.
"While the BoE looks genuinely minded to raise interest rates sooner rather than later, a hike before the end of 2017 still looks far from inevitable. The MPC could yet be deterred from acting if pay growth shows no sign of picking up over the coming weeks and the economy appears to be struggling during the autumn."