Bank split over interest rate rise

Thursday 21 August 2014

Two members of the Bank of England's monetary policy committee (MPC) have voted for a 0.25% hike in interest rates in the first split vote on rates since July 2011, it was disclosed yesterday.

Minutes of the MPC's meeting earlier this month showed that Ian McCafferty and Martin Weale dissented from the majority view of seven other members, including governor Mark Carney, that rates should be kept on hold.

The Bank rate has remained at 0.5% since 2009 when it was slashed to try to help nurse the economy back to health, with the UK's economic recovery fuelling speculation about when it will start to rise again. Rate-setters must weigh up the need to keep a lid on inflation with the risk that higher rates could derail the upturn.

Details of the latest discussions published by the Bank revealed that most still felt that "there remained insufficient evidence of inflationary pressures" to justify a hike.

But the minutes added: "For two members, in particular, economic circumstances were sufficient to justify an immediate rise in Bank rate."

The pound climbed a cent against the euro and was also up against the US dollar. Markets have pencilled in the first rate rise for February 2015.

Details of the minutes were disclosed a day after figures showing a sharp fall in inflation to 1.6% appeared to end any prospects of rates being lifted this year  These had already been dampened last week by figures showing wages falling 0.2%, and the Bank's Inflation Report putting extra emphasis the importance of the pay data when considering the path of rates.

Bank forecasts suggest inflation will remain close to but a little below 2% for the next couple of years. It expects the UK economy to grow by 3.5% this year but the minutes said expansion "was likely to ease a little as the boost from pent-up demand released by the easing in credit conditions and lifting of uncertainty faded". This would slow the pace at which "slack" or wasteful spare capacity is being eroded.

Slack is the key measure that policy makers want to see reduced before any rate hike and last week the Bank said it was estimated to have fallen from 1.25% to 1%. But it has said the weakness of wages suggest this capacity gap might have been greater than previously thought.

Reasons given for poor performance of pay include a larger labour supply as people work longer, partly because of concerns about pensions and debt levels, as well as employees concerns about their positions.

The minutes said: "Given the risk that an increase in labour supply or persistent concerns over job security would result in weak growth continuing for longer, there would be merit in waiting to see firmer evidence that solid increase in pay growth were in prospect before tightening policy."

This was one of the arguments of the majority on the committee who wanted to leave rates on hold.

These also cited headwinds facing the economy including weak eurozone growth, and the risk that a premature rates hike "might leave the economy vulnerable to shocks".

"In addition, increases in Bank rate well ahead of any pickup in wage and income growth risked increasing the vulnerability of highly-indebted households."

The minutes added that an unexpected hike would push up the pound further and hit "economic rebalancing" - amid hopes of exports picking up. But they acknowledged that growth meant the time for an increase was coming, saying that "the longer the expansion continued, the less likely it became that some of the downside risks to growth and inflation would appear".

The dissenting members of the MPC argued that wages may be weak because they were lagging behind developments in the labour market - where employment numbers have been growing strongly. They argued that since monetary policy also took time to take effect, it was "desirable to anticipate labour market pressures by raising Bank rate in advance of them" - in other words, not waiting until pay inevitably does grow before a hike.

The members suggested that a 0.25% rate rise would still be "extremely supportive" to the economy and would help the MPC achieve its aim that further rises should only be gradual. They said delaying the hike was unlikely to lessen the risks of the market reaction to the first increase and could add to them.

The split was the first on the MPC on either rates or quantitative easing (QE) - which injects billions into the economy - since Mr Carney became governor last summer.

Predecessor Lord King saw a series of splits right up until his departure over QE, when he and two other members had taken the minority view that it should be increased by £25 billion.

The last dissent on rates occurred in July 2011 when Mr Weale and former chief economist Spencer Dale, who has now left the Bank, voted for a 0.25% hike.

Samuel Tombs of Capital Economics said the latest minutes "suggest that it would be foolish to rule out the possibility of a 2014 rate hike" though he still expected this would happen in February.

Jeremy Cook, chief economist at currency exchange company World First, said: "A marker has been put down and we only need three more members of the MPC to switch allegiance and we will have higher rates in the UK."