UK: Why rates won’t rise in 2017 - HSBC

Liz Martins, UK Economist at HSBC, notes that following the latest batch of strong data from the UK and some more hawkish sounding noises from Bank of England (BoE) Governor Mark Carney, speculation is rising over the possibility of a rate rise.

Key Quotes

“The market-implied probability that the Bank will have reversed August’s 25bp cut by December 2017 has risen to around 40%. We can see why: activity is strong, the labour market is tight and inflation is picking up. Moreover, the global economy appears to be in an upswing, and the US has already raised rates twice since the global financial crisis. If the recent strength in UK data is sustained, then we have all the ingredients for a hike.”

“Times are not normal, however. The UK faces a turbulent year ahead. Higher inflation has already started to erode real wage growth: we think it will drop into negative territory in the coming months, weighing on consumption. Even if the BoE raises its growth forecasts again in February, as it has hinted it might, we think it will still see a slowdown as the most likely scenario.”

“The bar for a rate rise is high

Our view is this: the Bank of England did not raise rates in 2011 when inflation was over 5%. Nor did it move in 2014/5 when the post-crisis recovery was in full throttle and the labour market was tightening fast. In August 2016, with inflation forecast to be substantially above target, it cut rates and launched QE. With uncertainty high as the Brexit negotiations get underway, and confidence potentially fragile, we do not see it pulling the trigger in 2017.”

“Of course, it is not 2011. The output gap is smaller and the labour market is tighter. But we are not persuaded that the structural story that has kept rates low till now has changed meaningfully. In a year full of uncertainty, even if you think our forecasts are overly pessimistic, raising rates will still be seen as risky. Rather, we think the Bank will look through higher inflation, passing it off as imported, rather than domestically generated. There are limits of course. But even our relatively high forecasts – a round trip to 3.7% and back down again – mean these limits will not be tested, in our view. We see rates staying on hold until the end of 2018 at least.”