Despite Inflation BOE Needs To Justify Rate Rise With Growth

(MENAFN- ValueWalk) Of all the challenges currently facing the bank of England, the one target policymakers are having no problem meeting with rising inflation, which is likely the envy of Yellen, Kuroda and Draghi.

CPI inflation came in at 3.0% in September — above the 2.8% year-on-year the Bank had penciled in back in August — 100 basis points above the central bank's 2% target.

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Rising Inflation has increased speculation that the Monetary Policy Committee will raise interest rates for the first time in nearly a decade when it meets next week. A 0.25% hike would take the central bank's leading lending rate to 0.5%.

The Sterling Effect on Rising Inflation And Wages

Brexit is entirely to blame for the current bout of inflation. 'In the long run, a 10% fall in the value of sterling relative to the euro increases UK prices by 3.8%,' almost twice the standard BoE assumption of 2%. Stirling has been the earliest casualty of Brexit.

But the Bank of England's path is not clear. Key UK economic indicators have shown softness in recent months. The Blue Book revisions (mainly to 2016 data) have reduced the annual rate of GDP growth from 1.7% in Q2 to 1.5%. The BOE itself is forecasting third-quarter GDP growth of only 0.3% quarter-on-quarter taking full-year growth to 1.4% --- the lowest since Q2 2012. Meanwhile, wage growth is extremely sluggish. Recent data shows wage growth at 2.2% year-on-year for total pay and the latest release for unit labour cost growth showed a fall to 2.4% in Q2 2017 -- the lowest in the last four quarters. Retail sales growth is now running at just over 1% year-on-year -- down from 7.2% in October 2016.

According to Liz Martins UK Economist at HSBC, it doesn't look as if the bank is going to see any let up in inflation anytime soon:

"CPI inflation has surprised to the upside relative to the Bank's forecasts and oil has risen by 14% since the last Inflation Report (though some of this rise is already evident in the Q3 overshoot). We think the MPC will raise its near-term forecasts to reflect this, taking inflation to 3.0% for both Q4 2017 and Q1 2018 (with a possible short-lived rise above that level in the monthly profile). Further out, we think they will keep inflation above target, leaving the door open to further tightening. If the new forecast profile shows inflation coming back down to target, then the MPC will be effectively rubber-stamping the current market curve, which will probably be interpreted as dovish."

BOE Needs To Justify Rate Rise With Rising Inflation, Growth

The BOE is going to have to undertake a delicate balancing act. On the one hand, there's a strong view that it should try to control inflation through higher rates, which would also make life easier for savers. On the other hand, a rate rise may destabilise a weakening economy, and the bank has no room for further monetary policy actions to stimulate demand.

Ultimately, to be able to justify a rate rise, BOE MPC members will have to justify that the economy is in good shape, and despite news, that suggests growth is still, present an optimistic outlook. HSBC explains:

"To justify a rate rise, the Bank will likely keep its upbeat assumptions from August: a smooth Brexit, a meaningful rise in wage growth, no rise in unemployment and an improvement in investment. However, we think its inflation projections will rise in the near-term, largely on the back of the 14% rise in oil prices. And the Bank will find it hard to avoid revising down GDP growth. Revisions to the back data have reduced annual growth. Add to this the impact of monetary tightening and we think the Bank's growth forecast will be revised down by 0.1ppts for each of 2017 (1.6%), 2018 (1.5%) and 2019 (1.7%)."



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