UK Bank of England raised interest rates 25 basis points: Walking not running - J.P. Morgan Asset Management
CLOSE

UK Bank of England raised interest rates 25 basis points: Walking not running

Contributors Karen Ward, Global Markets Insights Strategy Team

In brief

  • The Bank of England (BoE) monetary policy committee voted unanimously to raise interest rates by a quarter of a percentage point to 0.75%.
  • Governor Carney stressed that further increases would be gradual but all forecasts right now must be taken with a pinch of salt given Brexit uncertainty.

The Bank of England raised interest rates by 25 basis points today to 0.75%. The hike was fully priced in to the markets and although it came as a surprise that the vote was unanimous, there was relatively little market reaction.

In the press conference the Governor was at pains to stress that any further hikes will be gradual – that it was necessary to walk and not run.

‘Gradual’ is the buzz word for most central banks normalising policy. And yet the meaning differs wildly. For the US Federal Reserve gradual appears to translate to 25 basis points a quarter. For the Bank of England, gradual appears to mean 25 basis points per year.

There weren’t many meaningful changes to the Bank’s forecasts for growth or inflation (see table). The interesting new analysis is the Bank’s assessment of ‘R-star’. In simple terms this is the appropriate interest rate to deliver inflation to its 2% target in ‘steady state’ i.e. when the economy is not affected by short-term cyclical considerations including the uncertainty of Brexit. The Bank estimate this ‘R-star’ to be 2.5% nominal.

This is clearly well below the interest rates we might have considered to be ‘normal’ pre-crisis. The governor emphasised that we all need to get used to a new normal. The BoE’s assessment is that ‘normal’ real GDP growth is 1.5% and normal wage growth is 3% (in the ten years before the crisis these numbers were 3% and 4.5% respectively). Effectively the BoE are saying that while neither the economy - nor pay-cheques - feel particularly boomy, this is likely as good as it gets. A sombre message indeed.

A 2.5% nominal interest rate is still well above 0.75%. The Governor stressed that there are three particular headwinds likely to persist, which means interest rates are likely to remain below ‘R-star’. These are household and government deleveraging, low productivity and a higher degree of uncertainty because of Brexit.

We are slightly more optimistic than consensus on a few of these short-term headwinds. The government is likely to be increasingly tempted to loosen the fiscal purse strings (as the recent announcement of additional spending on the NHS shows). We expect the heads of terms of a relatively ‘soft Brexit’ to have been agreed between Prime Minister May and the EU by year end. And we believe some of the recent weakness in productivity is cyclical.

As a result, going into next year we expect the BoE to be moving back to ‘R-star’ a little more quickly than either it, or the market, anticipates right now. Given the Brexit negotiations are likely to drag into November it is unlikely the BoE hike again this year. But we expect at least two further 25 basis point hikes in 2019.

EXHIBIT 1: Forecasts were relatively unchanged from those produced in May


Source: Bank of England, J.P. Morgan Asset Management. y/y is year on year. Data as of 2 August 2018.

Related Solutions

J.P. Morgan Global Liquidity
Today’s complexities require a dedicated liquidity partner committed to helping clients succeed through all market cycles.
Performance & Yields
J.P. Morgan delivers comprehensive solutions based on the unique investment objectives of your organization.
Liquidity Insights
View original research, reports and commentary from our portfolio managers, analysts, economists, and traders.

Important information

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature or other purpose in any jurisdiction, nor is it a commitment from J.P. Morgan Asset Management or any of its subsidiaries to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical and for illustration purposes only. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own professional advisers, if any investment mentioned herein is believed to be suitable to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yields is not a reliable indicator of current and future results.

J.P. Morgan Asset Management is the brand for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide. This communication is issued in the United Kingdom by JPMorgan Asset Management (UK) Limited, which is authorized and regulated by the Financial Conduct Authority, Registered in England No. 01161446. Registered address: 25 Bank Street, Canary Wharf, London E14 5JP.