The Bank of England (BoE) has unanimously voted to raise interest rates to the highest level since the financial crisis.
The rate hike, which saw the bank rate increase 25 basis points to 0.75 per cent, is only the second increase since 2007.
Although UK inflation (2.4 per cent) is still above the 2 per cent target set by the central bank’s Monetary Policy Committee (MPC), it said this is due to external factors such as higher oil prices and a weaker sterling earlier in the year.
CPI inflation projection
Source: Bank of England
And, while global data has been softer than expected, the short-term outlook for the UK economy has moved in line with expectations and justifies the increase, it said.
Weak data from the first quarter has proven to be a temporary blip and is now picking up momentum again with positive GDP growth and low unemployment.
The MPC added that a tightening labour market and a lack of breathing space within the UK economy are other reasons why an increase in the bank rate was necessary.
A rate hike had already been priced in by markets, so no big reaction was expected. However, not all investors are certain it was the correct decision. Below, experts give their thoughts on the rise.
Simon Blundell, head of Sterling Bond portfolios at BlackRock
BlackRock’s Simon Blundell is one of the sceptics who believes it may have been too soon to raise the bank rate.
“With recent economic data arguably failing to justify a tightening and the continued uncertainty around Brexit, of more importance is the outlook from here,” he said.
“The market is only pricing for one more hike of 0.25 per cent through 2019 and another in 2020.
“This assumes a relatively benign outcome from the Brexit negotiations, which means in a negative scenario such as a “hard Brexit” or “no deal”, we would expect to see this small tightening probability being taken out of the market and a move to pricing potential rate cuts similar to what we saw post the referendum in 2016.”
Blundell did, on the flip side, comment that if the potential for a second referendum increased on the back of strong momentum, there would be a renewed chance of the UK remaining in the EU. At the moment however, this is not being priced into markets.
This scenario would lead to higher gilts yields and a rally in the pound alongside markets pricing a higher possibility of further tightening by the Bank.
Sajiv Vaid, portfolio manager of Fidelity MoneyBuilder Income fund
Fidelity’s Sajiv Vaid, although not in agreement with the BoE’s decision to raise rates, said it is too early to call it a policy mistake because the central bank does have some arguments on its side, even if tenuous.
“The expected recovery in Q2 GDP has indeed appeared, with GDP revised marginally higher, and leaves growth close to potential, while the consistently strong labour market keeps expectations of higher nominal wages alive, with recent public sector pay deals probably having played a role too,” he said.
Neil Williams, senior economic adviser at Hermes Investment Management
Hermes’ Williams noted that while the Bank raised rates to give them more “powder” to use in the event the economy slows downs, a reduction of its quantitative easing (QE) program may have been more effective.
“This is circular and the Bank will be mindful that raising rates too far does not cause that downturn,” he said.
“To keep the lid on rates, the Bank could in tandem start to whittle away its QE stock. Selling the assets is one for later to minimise the hit to the gilts market.
“However, as a first step, terminating the reinvestments - or initially tapering them US-style - would surely be the gentlest way of tightening policy. In effect, tightening by 'doing nothing'.”
In the meeting, the BoE agreed to continue its QE program and maintain the purchasing of government and corporate bonds, totalling £445bn.
Williams added: “It would help keep rates low and give the pound comfort the Bank was not falling 'behind the curve'. It may even go some way to reducing belatedly the downside of QE - still evidenced by asset-price distortions, suppressed saving, and funding strains still on many pension schemes.”
Matthew Russell, fixed income fund manager at M&G
M&G’s Russell was one investor who wasn’t surprised by the BoE’s decision to increase the bank rate.
“The unreliable boyfriend finally turned up with some flowers – after months of going back and forth, the Bank of England delivered what everybody had been expecting for months,” he said.
“The tightness of the labour market may have been the main reason behind all MPC members agreeing on the hike today – perhaps this tightening of the labour market is a bit beyond their comfort levels.
“This hike shouldn’t raise any eyebrows. Unemployment is at its lowest since 1975, unit labour costs are on the rise, PMIs are looking healthy and inflation is above target. Hence why increasing the rate by 25bps does not come as a surprise”.
UK unemployment in per cent
Source: Bank of England
Ben Brettell, senior economist at Hargreaves Lansdown
Brettell agreed that it was the right decision, citing the extra room for manoeuvre when the next downturn hits as the main reason for raising rates now.
“If interest rates are 1 per cent or more by the time the economy sails into stormier seas, policymakers will at least be able to cut rates a couple of times before cranking up the printing presses for more QE.
“So, on balance the Bank’s decision looks sensible. 0.5 per cent was supposed to be an ‘emergency’ level, and that was almost 10 years ago. The economy is undoubtedly much stronger today than in 2009.”
The economist caveated that the BoE made the mistake of cutting rates after the Brexit vote in 2016 from 0.5 per cent to 0.25 per cent.
Had the Bank held its nerve, rates could now be at the 1 per cent mark and its job could be somewhat easier, he said.