Interest rates stay on hold

The Bank of England’s Monetary Policy Committee has voted to hold the base rate and maintain quantitative easing at current levels.

Interest rates stay on hold

In response to the Brexit vote the Bank cut interest rates to 0.25% and increased quantitative easing back in August 2016.

In a meeting this morning, the Bank also updated its growth forecasts for the next two years; it now expects GDP to rise by 2% this year and 1.6% in 2018, up from 1.4% and 1.5% previously expected.

Commenting, Ben Brettell, senior economist at Hargreaves Lansdown, said: “The Bank of England faces a tough job in the coming months as it seeks to balance a surprisingly resilient economy, higher inflation and the difficult-to-quantify risks posed by Brexit.

“The economy has remained surprisingly robust in the aftermath of the vote to leave the EU, and today the Bank announced a big revision in its growth forecast for 2017. Growth of 2.0% is now expected, up from 1.4% in its November report.

“Since the November Inflation report there has been plenty of positive data, with growth of 0.6% in the final quarter. The PMI reading for the dominant services sector rose sharply in December, Q4 retail sales were 5.9% higher than a year earlier, and unemployment remains at an 11-year low.

“Inflation forecasts were little changed, with policymakers forecasting CPI inflation will peak at 2.8% in the first half of next year, before gradually falling back towards its 2% target.”

Tom Stevenson, investment director for personal investing at Fidelity International, believes this will create opportunities for investors:  “With the Old Lady of Threadneedle Street prepared to keep sitting on its hands when it comes to raising rates and with inflation expected to breach the central bank’s 2% target this year, anyone with savings still sitting in cash will struggle to generate real returns.

“One alternative is to look to the stock market. History shows there has been a sweet spot in the inflation range that suits equities well – normally at around 2% to 2.5%. Shares tend to perform particularly well if the rise in inflation reflects higher growth expectations rather than a wage spiral. This is the Goldilocks scenario for equities and it may well apply for much of this year and next.”

So are we likely to see interest rates rise in the near future? Ben Brettell doesn’t think so.

“Unsurprisingly interest rates were left on hold, but the minutes noted that some MPC members were getting a little closer to the limits of their tolerance for higher inflation,” he said. “This could mean we see the first interest rate rise in more than a decade at some point this year, particularly if wage growth turns out stronger than expected.

“However I still feel this is improbable. The most likely scenario is that higher inflation and weaker pay growth will squeeze household budgets, meaning consumer spending is likely to slow in real terms. The Bank is unlikely to take the risk of raising borrowing costs in this environment. If it does happen, I would expect rates to remain at their previous low of 0.5% for some significant time afterwards.”

Ian Kernohan, economist at Royal London Asset Management, agrees: “Following the relatively robust GDP report for the fourth quarter of 2016, the Bank of England has raised its GDP growth forecast for this year by more than I expected, but made little change to their inflation projection.

“The MPC expect inflation to overshoot the 2% target, however this rise is coming from very low levels and is driven by some temporary factors. Wage growth, a key indicator of underlying inflation, remains modest.

“With higher inflation set to squeeze household incomes this year, and the likely shape of the UK’s trading arrangements post-Brexit still very unclear, we think the MPC will be reluctant to add to these pressures on the economy by raising interest rates in the near future.”

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