Summary
The UK economy continues to expand. Low unemployment is supporting consumer spending; although weaker, business production is still positive.
The bank raised believes the economy is at or near full capacity, which means their rate hike was probably meant to ward-off potential inflation.
They said that all things being equal, another rate hike is probably coming.
On Thursday, the Bank of England raised rates 25 basis points to 75 bps.
From the bank's perspective, here are the key pieces of information.
Inflation is over 2%, but is weakening:
As the chart shows, an increase in housing costs (in black/dark blue) is one reason for the increase. The other is the sharp drop in the sterling after the Brexit vote:
The Brexit vote occurred in mid-2016 when the sterling was 1.25-1.3 to teh euro. It has since fallen to slightly under 1.15.
Unemployment is low:
And while GDP growth is slowing, it's still positive:
In general, the UK economy has survived despite the strife of Brexit. Low unemployment is supporting high consumer sentiment, which led to a solid uptick in retail sales in the 2Q18. Consumers are saving less, however, to support their spending. According to ONS data, manufacturing and production is modestly weaker in the 1H2018. But according to the latest Markit press release, new orders and production were still expanding. The same report noted that exports had their best results in six months. However, intermediate goods production contracted for the first time in two years. And bank lending is weaker which is causing lower investment. But this could also be a function of Brexit uncertainty.
Why did the bank raise rates? From their release [author's emboldening]:
In the MPC’s central forecast, conditioned on the gently rising path of Bank Rate implied by current market yields, GDP is expected to grow by around 1¾% per year on average over the forecast period. Global demand grows above its estimated potential rate and financial conditions remain accommodative, although both are somewhat less supportive of UK activity over the forecast period. Net trade and business investment continue to support UK activity, while consumption grows in line with the subdued pace of real incomes.
Although modest by historical standards, the projected pace of GDP growth over the forecast is slightly faster than the diminished rate of supply growth, which averages around 1½% per year. The MPC continues to judge that the UK economy currently has a very limited degree of slack. Unemployment is low and is projected to fall a little further. In the MPC’s central projection, therefore, a small margin of excess demand emerges by late 2019 and builds thereafter, feeding through into higher growth in domestic costs than has been seen over recent years.
There are two reasons. First, the economy is at full capacity; total output is at/near theoretical output. Should the pace of any sector pick-up, inflationary pressures -- followed by inflation -- will rise. Second, I think the very low unemployment rate is leading them to think higher wage growth is coming and they want to raise rates now to cut off major inflationary pressures now. From the latest Inflation Report [author's emboldening]:
Private sector regular pay growth has also strengthened, to a little under 3% in recent months. Other indicators of private sector pay pressures have also risen. Private sector settlements data are consistent with an increase in median pay growth of around 0.5 percentage points relative to a year ago. The Bank’s Agents’ measure of average growth in labor costs has picked up in recent quarters (Chart 3.8). The REC pay survey, which is a measure of the pay growth of new recruits, also implies a strengthening in pay growth.
In the public sector, AWE growth has picked up notably over the past year, although it softened slightly in the three months to May. Excluding bonuses, public sector pay growth has risen from around 1½% to 2¼% — having been somewhat more subdued than private sector pay growth since 2014
Finally, the bank also stated another rate hike was probably in the cards in the near future.
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