Uncertainty is still the word that defines UK politics and economics at the moment. Base rates might remain at the record low of 0.25%, but at last month’s Monetary Policy Committee (MPC) meeting, the Bank of England struck a more hawkish tone, with three members voting to raise interest rates. UK CPI inflation has increased to an annual 2.9% in May, its highest level in four years, suggesting a rate rise could come sooner rather than later.
“the possibility of the MPC voting for a rise in rates now seems higher”
Comments made by the Bank of England governor, Mark Carney, following the interest rate decision only further heightened the expectation for tighter monetary policy. His acknowledgement that the Bank of England may need to increase rates and withdraw some of its stimulus package if inflation remained high, wages firmed and business investment picked up, means that the possibility of the MPC voting for a rise in rates now seems higher, with the market forecasting that the Bank of England will tighten monetary policy by the end of 2017. As a result the market saw gilt yields and swap rates increasing at the end of June.
“the impact of all this uncertainty has been an ongoing weakness in sterling, which is likely to spur inflation.”
However, the political landscape and current wage data would make it a surprising time for a rate increase in the near term. June’s general election result, which saw the Conservative government lose its majority, was not the expected result and the knock-on implications for Brexit negotiations are yet to be fully understood. The outcome of Britain’s decision to leave the EU has always been shrouded in uncertainty, and an absence of ‘strong and stable’ government in the UK has not made the picture any clearer.
“weak wage growth data has shown the highest annual fall in three years”
Although the pound moved to a three-week high against the dollar in the aftermath of Mark Carney’s remarks to $1.2913, the impact of all this uncertainty has been an ongoing weakness in sterling, which is likely to spur inflation. However, recent weak wage growth data has shown the highest annual fall in three years, down 1.5% year-on-year in April. This outcome of higher consumer prices but lower wages is not good for consumers in general and mortgage customers particularly. With a risk of stagnant wage growth, a rate rise could be delayed.
Looking at data from the financial markets and the UK’s economic outlook, markets forecast the current low 0.25% base rate to persist in the short term, before rising to 0.5% in around 12 months. Over the course of the next two years, markets expect an increase to 0.75%. For three-month LIBOR, markets expect to see a rise to 0.5% in six months in line with Borrowing Base Rate forecasts.