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Last week the Bank of England’s Monetary Policy Committee (MPC) voted unanimously to raise interest rates to 0.75% from 0.5%. This is the highest they have been in almost a decade, although they are still very low by historical standards.
Prior to the decision to raise interest rates in November 2017, interest rates had not been raised since the summer of 2007. Now, in the space of a year the MPC has voted to increase rates on two occasions. As the chart below shows, however, they remain well below the levels seen at the time of the 2007-2009 financial crisis.
The Government has set the MPC a 2% inflation target, and the MPC will adjust interest rates with the primary intention of meeting this target.
In June 2018, the CPI inflation rate was 2.4%, unchanged from May but below levels seen for much of 2017 and the start of 2018, when it was around 3.0%. These higher rates of inflation were partly a result of a rise in import prices due to sterling’s fall following the EU referendum. The last time inflation was either equal to or less than the 2% inflation target was in January 2017.
The MPC stated that most of the rise in import prices has now been passed on to consumer prices, and therefore have forecast that the inflation rate will begin to gradually decline towards the 2% target, reaching it around the end of 2020.
Following the March meeting of the MPC, the expectation was that its members would vote to raise interest rates at the May meeting. However, at this meeting, the MPC voted to keep interest rates unchanged at 0.5%, with a key reason for this being the economic slowdown in the first quarter of this year. Provisional estimates of GDP had showed growth of only 0.1% in this quarter, which was the slowest growth since 2012. The estimate for this quarter has since been revised to 0.2%.
A key question since then has been whether this subdued growth was a temporary dip, at least partly caused by the adverse weather in this quarter, or whether it would prove to be part of a more sustained slowdown.
The economic data published since the May meeting has been mixed but sufficiently strong for the MPC to conclude that the first quarter slowdown was temporary, and that momentum has recovered somewhat in the second quarter.
The MPC has reported that it expects growth to be 0.4% in Q2 2018. The ONS will publish a first estimate for this quarter on Friday August 10.
The number of people who are unemployed fell by 12,000 in the three months to May 2018, with a fall of over a million people over the last five years. The unemployment rate was at its joint lowest rate since 1975 in this period, and the rate is projected to fall further in the second half of 2018.
A consequence of the low levels of unemployment is an expectation that there will be an acceleration in wage growth over coming years. The MPC has stated that this could lead to inflationary pressures.
Despite interest rates being raised on two occasions in the last year, they remain at a very low level, and the MPC has stated that future increases “are likely to be a gradual pace and to a limited extent”.
As a result it seems unlikely that rates will quickly rise back to the levels seen prior to the financial crisis. Mark Carney has stated that a good rule of thumb for future interest rate rises, is one quarter point rise a year for the next three years.