However, the foreign exchange markets were disappointed by the cautious tone of today’s announcement and the Pound dropped sharply as a result.
Interest rates rise to 0.5%
The MPC voted 7-2 to raise interest rates by 0.25% to 0.5%, reversing the emergency cut made in August last year after the EU referendum result. The decision was far from a surprise after the MPC suggested a rate hike would be appropriate in the “coming months” at their last meeting. The main catalyst for tightening monetary policy is to contain above target inflation, which has soared to 3% from just over 0.5% before the referendum due to the sharp devaluation of the Pound.
The accompanying statement said that, “the MPC now judges it appropriate to tighten modestly the stance of monetary policy in order to return inflation sustainably to the target”. However, it also repeated previous guidance that, “All members agree that any future increases in Bank Rate would be expected to be at a gradual pace and to a limited extent.”
Pound drops on dovish outlook
As the market had already priced in a 0.25% increase at today’s meeting, the key question on the foreign exchange markets was: what next?
Investors had been hoping to see some indication that this would be the first of a series of rate increases over the coming months. However, the minutes of today’s meeting did not include language from previous statements that indicated more hikes could be coming.
Instead, the Bank of England indicated that rates will only need to rise to 1% by 2020, which is more dovish than had been expected. This caused the Pound to fall over 1% against the Euro and the Dollar.
Could Brexit negotiations prompt policy change?
In his accompanying press conference, Governor Mark Carney said that the most likely reason to adjust interest rates in either direction is some resolution of the big issues around Brexit. He suggested clarity on a transition deal and the future relationship would be likely to boost growth, and in turn prompt a policy adjustment.
This means that, as always, the financial markets will be watching closely when Brexit negotiations resume next week.
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