Bank of England Keeps Interest Rate Unchanged

  • Jun 20, 2019 BST
  • Team Kalkine
Bank of England Keeps Interest Rate Unchanged

The Bank of England has voted unanimously to keep their monetary policy unchanged with the base rate remaining at 0.75% following their latest meeting and cut its growth forecast for the economy to zero in the second quarter of 2019, highlighting global trade risks and growing fears of a damaging no-deal Brexit. The bank Governor Mark Carney had previously talked of the need for higher borrowing costs in the not-too-distant future but took a more conciliatory approach in the latest meeting and stuck to its message that rates would need to rise in a limited and gradual fashion.

The market had expected to leave its base bank rate untouched with a unanimous vote. While Sterling extended its losses against the dollar in reaction to the news, falling from 1.2723 to 1.2694 and falling 0.4% against the euro to 89.09 pence, UK 10-year gilt yields fell to a day's low of 0.809% following the decision. Trading 0.5% higher during the afternoon session, the FTSE 100 extended its gains. The base rate remains at an all-time low despite two 25 basis point hikes in the last two years, and Mr Carney and the members of the MPC have repeatedly said that they want to increase the rate gradually.

Money markets show investors see virtually no chance of a rate hike until at least mid-2020 as Brexit and the ebbing economic expansion have made it difficult for the bank to get back to normalising the interest rates. The main reason why the central bank opted to keep rates on hold was the concerns about the economic outlook due to uncertainty surrounding Britain's departure from the European Union, primarily due to the risk that Boris Johnson would win become the leader of the Conservative party and lead the country out of Brexit, with or without a deal.

The parliament and the financial community are strongly against a no-deal Brexit, and the pound has fallen 5% since early May on fears that Mr Johnson would become the next Prime Minister after the resignation of Prime Minister Theresa May. The Brexit process remains increasingly unclear and political turmoil continues to persist. While investors have increasingly priced in the risk of a no-deal departure under a new government in October, the Bank of England remains rooted in the assumption of a smooth Brexit process.

Reflecting subdued global growth and ongoing Brexit uncertainties, the Monetary Policy Committee in the May Inflation Report projected GDP growth to be a little below potential during 2019 as a whole. However, as global trade tensions intensified, downside risks to growth have increased since the last projections. The committee also noted that the possibility of a no-deal Brexit has risen. Trade concerns have contributed fall in industrial metals prices, as well as volatility in corporate bond spreads and global equity prices. The UK forward interest rates have experienced additional downward pressure from increased Brexit uncertainties, while forward interest rates in major economies have also fallen materially further.

Due to Brexit-related effects on financial markets and businesses, recent UK data have been volatile and the GDP in the second quarter is now forecasted to be flat, after rising by 0.5% in 2019 Q1. Ahead of recent Brexit deadlines, significant stocks had been kept by companies in the United Kingdom and the European Union in the first quarter, but the positive contribution of this to GDP is now forecasted to unwind, leading to further drag on economic growth. The bank said that weak business investment has persisted, but the underlying growth of household consumption remained strong. It also added that, relative to the first half of 2018, the underlying growth in the country weakened in 2019 to a rate below its potential.

According to the latest inflation figures, the headline UK inflation rate cooled in May to 2.0% annually from 2.1% in April, reversing three months of increases, while core inflation, which excludes food, alcohol and energy, dropped from 1.8 per cent to 1.7 per cent, the lowest level since the start of 2017. Cheaper air travel and car prices pulled down the inflation and costs in manufacturing dropped to a three-year low. Even though the overall case for normalising interest rates is clear, the latest figures might have convinced the MPC that there is no urgent need to raise the rates. The outlook for inflation may also give officials pause for thought as economists see the downward trend continuing, with factory output-price growth weakened and slowing core inflation. The central bank expects inflation to ease to about 1.6% by late 2019, falling below its target this year. Inflation had hit a two-year low of 1.8 per cent in January and the manufacturing output fell the most in almost 17 years in April. While goods-price inflation edged up to 1.5%, service sector inflation, which serves as a proxy for domestically generated inflation, fell from 2.9% in April to 2.6% in May.

The Bank of England met in a week where other central banks have taken a decidedly dovish turn, as European Central Bank President Mario Draghi pledged new stimulus if the outlook doesn't improve, while the US Federal Reserve signalled that the next move would be an interest rate cut rather than a hike. Unlike the Monetary Policy Committee, which continued with its previous guidance on interest rates, the Fed and the European Central Bank have both signalled a willingness to consider lower interest rates. Last month, Governor Mark Carney warned investors were underestimating how much interest rates could rise, but significant negative factors made it difficult for it to convince investors that it is to bring rates to a more historical plane. BoE Chief Economist Andy Haldane said this month that the time was nearing for a rate rise to prevent inflation pressure building, but the global slowdown is one reason why the warning that the market is not pricing in enough future increases failed to get the attention of investors.

The recent minutes of the meeting indicate a softer stance by the bank compared to a previous warning that the market curve doesn't reflect more rate hikes. As the remaining candidates in the race to succeed Prime Minister refuse to exclude the prospect of leaving without a new arrangement in place, the assumption of a smooth Brexit, which implies the need for modest policy tightening, looks more fragile now, leaving the bank in a tight spot. The bank acknowledged this in its latest meeting and said that the economic outlook would continue to depend significantly on the nature and timing of the withdrawal, and the monetary policy response to Brexit will not be automatic and could be in either direction. The central bank also said that it would take into account how households, businesses and financial markets respond to the transition in order to achieve the 2% inflation target.

The labour market, which showed that basic pay growth unexpectedly accelerated to 3.4% and the number of people in work rose more than forecast in the three months through April, remains a bright spot for the UK economy and is the source of the hawkish bias of the bank. Market movers see virtually no chance of a rate hike until at least mid-2020, though credit pricing indicates that traders believe a rate cut is the next likely move, like in the United States.

With Bank of England reducing the interest rates to a historic low level, the spotlight is back on diverse investment opportunities. 

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