Rates likely to rise in Q2 2016

The media is wrong to interpret the Bank of England’s inflation figures and statements to mean interest rates will be kept at 0.5% until at least 2017, writes Ryan Bembridge.

Rates likely to rise in Q2 2016

Following yesterday’s decision on interest rates by the Monetary Policy Committee, media outlets widely reported that the Bank of England signalled rates would stay at rock bottom levels until 2017.

This was because growth forecasts were cut, with the Bank saying it expected inflation to stay below 1% until the second half of next year.

Since the last inflation report in August the Bank said the “path for interest rates rises implied by the market rates has fallen by around 40 basis points”.

But both Vicky Redwood and Samuel Tombs, chief UK economists at Capital Economics and Pantheon Macroeconomics respectively, said the MPC will start to raise interest rates ahead of the 2% inflation target being surpassed, while they both agreed that rates will rise in the second quarter of 2016.

Redwood said: “I don’t think the Bank of England was trying to convey the message that interest rates will be held until in 2017.

“People need to bear in mind that interest rates should be adjusted 18 months before projected inflation figures take effect.

“Holding interests rates for that long would put too much stimulus on the economy and leave the inflation above target in 2017.

“Rates will likely be raised when inflation hits about 1% because the Monetary Policy Committee wants to be forward looking.

“I am sticking with a prediction of quarter two 2016.”

Tombs’ views corresponded almost exactly. He said: “The inflation report was a bit more dovish than people expected, but Bank governor Mark Carney didn’t mention any quarter when rates would rise.

“The MPC thinks inflation will be above the 2% target in 2017, so if they waited as long as the markets expect them to before raising interest rates inflation would climb above the target, which points to a rate rise in Q2 or Q3 2016.

“It takes a while for changes in interest rates to go through into inflation. In normal times you would base your base rate decision on where you think inflation would be in two years’ time because it takes that long for changes to take effect.

“The MPC wants to see inflation rise first before the rate hike, so when inflation is at 1% in the second quarter that will be enough to convince them that inflation will hit its 2% target in 2017.”

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