Unemployment increased in July for the second month in a row, adding weight to the arguments of rate setters in the ‘lower for longer’ camp.
This was before Black Monday last week, when market falls across the world made many believe it even more likely that a UK interest rate rise would be pushed back.
Rates were held in August by an MPC vote of eight to one, with the Bank’s inflation report suggesting an initial rise would come around February.
According to IHS Global Insight economist Howard Archer, how earnings develop over the coming months will play a crucial role in when the Bank starts to raise rates.
“Should earnings growth pick up markedly over the coming months, it would increase the likelihood that the Bank will raise interest rates early on in 2016,” he says.
The Bank’s inflation report suggested rates would rise in line with current market expectations. However, its data and charts highlighted how those expectations had shifted in the past three months.
Within the inflation report, the Bank said: “The MPC judges that it is currently appropriate to set policy so that it is likely inflation will return to the 2 per cent target within two years. Conditional on a gradual rise in Bank rate, such as that currently implied by market yields, that is judged likely to be achieved.
“The MPC’s projections are conditioned on a higher exchange rate and a slightly steeper path for Bank rate than those in the May report. The conditioning path for Bank rate rises from early 2016 to reach 1.7 per cent by Q3 2018, around 0.25 percentage points higher than in May.”
This was the first time this year that any MPC member had called for a hike. As the year continues, more members are expected to be convinced of the need to start moving off the emergency measure of 0.5 per cent.
According to Archer, the Bank of England is likely to edge up rates from 0.5 per cent to 0.75 per cent in February. He believes the risk of an earlier move has waned markedly.
“Further out, we see interest rates rising only gradually to 1.25 per cent by the end of 2016, 2 per cent by the end of 2017 and 2.5 per cent by the end of 2018,” he says.
Core inflation, which strips out volatile food and energy prices, is only at 0.7 per cent and its recent trajectory is flat, if not downward. The outlook for commodity prices, particularly oil, remains subdued following a pessimistic reassessment of Chinese prospects.
So what impact has the recent sell-off in global markets had on rate expectations? Analysts at Citi believe the triple threat of a slowdown in China and the impact of higher US interest rates on global growth alongside the market turmoil could mean UK interest rates being kept on hold until 2017.
While the group’s chief UK economist, Michael Saunders, still expects the Bank to start raising rates in early 2016, he says weak inflation means it would not be a big step to expect the rate at the end of 2015 to be back at 0.5 per cent.
According to Saunders, solid UK growth and higher consumer confidence suggest labour costs and wage growth will continue to pick up over the next 12 months, leading to stronger domestic inflationary pressures.
However, inflation, as measured by the Consumer Prices Index, is expected to average just 1.1 per cent this year and that is without factoring in the recent market turmoil. There is a risk that weakness in emerging markets and faltering global growth could push inflation even lower in the coming months, Saunders added.
If equities stabilise soon and downside growth risks recede, an early-2016 hike would remain valid. However, if the global growth outlook does deteriorate significantly further and/or market turmoil continues, then, given the low inflation outlook, it would not be a big step to expect the Bank rate to be at current levels in nine to 12 months’ time.
It is almost certain we shall see no changes in base rate or quantitative easing when the MPC meets later this month against the backdrop of fragile sentiment in global financial markets.