Market News

Will the Bank of England increase the Bank rate in May?

The Federal Reserve (Fed) hiked interest rates in March and the Bank of England is likely to follow suit in May.

23/03/2018

Janet Mui

Janet Mui

Global Economist

Federal Open Market Committee (FOMC) meeting – Wednesday 21st March
The FOMC raised the Federal funds rate by 0.25% as expected from 1.5% to 1.75%. The FOMC did not add a fourth rate increase to its 2018 rate projections, but it did raise the overall Federal funds rate profile by adding one more hike in 2019. This makes three hikes compared to the two previously expected in December 2017. As a result, the Federal funds rate projection for 2019 was unchanged at 2.1% in 2018; it was revised from 2.7% to 2.9% in 2019 and from 3.1% to 3.4% in 2020. The longer-run rate projection was lifted from 2.8% to 2.9%.

On economic projections, FOMC turned more bullish on growth outlook, increasing 2018 and 2019 GDP growth forecasts (still below consensus forecasts), driven by the positive impact from the fiscal package. Unemployment rate was lowered over the forecast horizon, notably in 2020 where there has been a 0.4% downward revision to 3.6%, almost a full percentage point below the longer-term equilibrium estimate. On inflation, core personal consumption expenditure (PCE) prices inflation has increased by 0.1% to 2.1% in both 2019 and 2020, which is rather benign and suggests the FOMC are not overly concerned about the risk of an inflation overshoot.

Ahead of the meeting, markets had more hawkish expectation on 2018 rate projection compared to that of the FOMC (which is rarely the case). The unchanged expectation of three rate hikes in 2018 was a less hawkish outcome for the markets, despite an overall lift in rate profile until 2020. Our view is that US inflation is trending higher, but not at a startling rate, and the Fed is in no urgent need to adjust policy more aggressively at this stage.

UK Monetary Policy Committee (MPC) meeting – Thursday 22nd March
The MPC voted 7-2 to keep policy on hold at its March meeting. Ian McCafferty and Michael Saunders voted to increase the Bank Rate by 0.25%, citing concerns that slack in the economy was largely used up and that wage growth was picking up, thus presenting increased risks to inflation in the medium term. Although the MPC has not increased interest rates, the policy statement retains a hawkish tilt and paves the way for a rate increase in May, which we now believe is a highly probable.

Despite the weaker UK inflation report and some softening in economic indicators, the MPC did not argue against a rate hike in its macro discussion. It remained constructive on global growth and confident that the positive trend in wage growth will persist. The MPC judged that data development since the last meeting was in line with the committee’s expectations and concluded that “given the prospect of excess demand over the forecast period, an ongoing tightening of monetary policy over the forecast period will be appropriate to return inflation sustainably to its target at a more conventional horizon.” Reflecting the hawkish tone from the vote and statement, the implied probability from Bloomberg of a rate increase in May jumped from 60% to 73% at the time of writing.  

Author

Janet Mui

Janet Mui

Global Economist

Janet is an Economist working in the Investment Strategy Team and a CFA charterholder. She joined in 2011 and previously worked in Citi Hong Kong as an analyst in Global Portfolio Management and subsequently as a relationship manager to multi-national clients. Janet graduated with a BSc in Economics from the London School of Economics (first class honours), holds an MBA in Finance from the University of Cambridge and obtained a Postgraduate Certificate in Econometrics from Birkbeck College, University of London.

  Janet Mui

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