Back in September, the Pound received a boost when the Bank of England suggested that it was considering raising interest rates in the near future. Since then, there has been ongoing speculation about when they will reverse the 0.25% interest rate cut that was implemented last year after the EU referendum.
The market currently suggests there is around a 90% chance that there will be an interest rate rise at the Monetary Policy Committee (MPC) meeting on Thursday 2nd November. However, there are a number of factors that will influence their decisions.
The case for raising interest rates
Members of the MPC who have been calling for a rate rise in recent months, such as Ian McCafferty and Michael Saunders, have frequently argued that a rate rise is necessary to curb inflation. Annual consumer price inflation was rising by just 0.5% before the referendum, but has soared higher due to the sharp devaluation of the Pound. The most recent data showed inflation rose to a five year high of 3% in September, increasing expectations that the committee will increase interest rates in November.
The recent release of third quarter GDP figures could also strengthen the case for raising interest rates. The latest figures show that the UK economy grew 0.4% in the three months to September, beating expectations and showing the economy may be gradually picking up speed after 0.2% growth in Q1 and 0.3% in Q2. Some economists have described this as a “green light” for the Bank of England to proceed with an interest rate rise next week.
The case against raising interest rates
The two newest members of the Monetary Policy Committee, Sir Dave Ramsden and Silvana Tenreyro, have both spoke out recently against increasing interest rates. Ramsden stated that at the last committee meeting in September, “A majority saw a case for removing some monetary policy stimulus in coming months… I was not part of that majority”. Tenreyro warned that, “A premature increase might be very contractionary, so a mistake there might be very costly”.
Some groups have pointed out that the recent rise in UK inflation is likely to be temporary, as the economy adjusts to the Pound’s depreciation over the last year, and argue that the Bank of England should wait until the economy is in a stronger position before raising borrowing costs. There are some suggestions that, although economic growth was slightly stronger than expected, it is still not strong enough to justify an increase in interest rates. Some concerns also remain about weak wage growth and uncertainty around Brexit.
What does this mean for the Pound?
The Pound responded positively to statements in September that an interest rate rise could be appropriate “over the coming months”. It also strengthened following the release of the third quarter GDP figures. We would expect a vote to increase interest rates next week to be positive for the Pound, particularly if the Bank’s economic growth forecasts are upgraded and they signal that further hikes are possible.
However, it remains possible that the Bank of England could vote to keep interest rates on hold next week, which would be likely to result in a slump in Sterling given the market’s expectations.
In the meantime, Brexit continues to create volatility in the Pound, as investors try to deduce what the outcome of negotiations will mean for the UK economy.
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