With Britain’s economy booming the expectations for when the Bank of England (BoE) will raise interest rates has hit a fever pitch. It seems it’s all analysts, economists, and investors are talking about of late, yet lost in the din is the BoE governor’s consistent insistence that no move will be made in short order.
Incredibly, about one year ago, the British economy was teetering on the brink of a triple-dip recession that threatened to derail the U.K.’s tentative recovery. Now, it is the veritable envy of the Group of Seven and the European Union.
Poised to be the fastest growing major European economy in 2014, the U.K.’s gross domestic product (GDP) growth is expected to be in the range of 2% to 3%, and according to PricewaterhouseCoopers, British GDP should rise to pre-recession levels by the fourth quarter. Meanwhile, the International Monetary Fund has pegged the U.K. economy to grow by 2.9% in 2014.
As the British unemployment rate continues to decline toward the BoE Monetary Policy Committee’s (MPC) 7% employment threshold, it sets the stage for the BoE to conclude Britain’s economic recovery is indeed sustainable. Thus the probability for the Old Lady to wind down its massive £375-billion stimulus program – called the Asset Purchase Facility – and increase interest rates by the end of the calendar year grows in tandem with the British Isles’ improving economic climate.
On the surface, it’s smashing news and a prudently optimistic Mark Carney, the BoE governor, acknowledged the positive signs not long ago. However, Carney also cautioned that long-term growth across all industries and real wage increases remain to be seen. Of equal concern for the BoE, England’s housing market could be inching toward another crash.
Policymaker Dissent on the Rise
Such a fragile state of affairs requires a deft touch and a flexible strategy. With the BoE’s base interest rate sitting at a record low 0.5% since 2009, fractures in the Bank’s formerly unified group of rate setters are starting to emerge.
Hawkish MPC members emboldened by the improving economic picture fancy a modest rate hike by year’s end, while more dovish policymakers look to so-called “spare capacity” in the economy as arguments ensue over which key indicators to rely on in the wake of the Bank’s forward-guidance policy. Presiding over them all is a headstrong Carney who must abide by the MPC’s determination of how and when the stimulus program should be reduced.
Therein is the crux of the matter: consumers’ disposable income will quickly evaporate with a rate hike and that could choke off the economic recovery. And with one modest rate hike, another is sure to follow, again impacting consumer spending behavior.
According to the Office for National Statistics (ONS), British inflation is presently sitting below the BoE’s 2% target at 1.8%, rising in April from 1.6% in March, and marking the first increase in inflation in about 10 months. Meanwhile, after six years of watching real earnings fall by an estimated 10%, business confidence is on the climb with expectations that incomes will grow, albeit slowly. Threadneedle Street’s quarterly Inflation Report was released earlier this month and it revealed the U.K. faces no inflationary pressure. That too will fuel the rate-hike discussion and stir investor sentiment over the timing of when the BoE will act.
Some economists critical of the Asset Purchase Facility have labeled it a “Robin Hood tax in reverse” that has merely served to redistribute wealth among the rich while the vast majority contend with a cost-of-living crisis. The ONS’s latest U.K. inflation data will do nil to quell that argument.
Strengthening Economy, Poorer Britons
With the slow growth in incomes and living standards, Britons may find themselves poorer by the time the next general election arrives in May, 2015.
According to data compiled by the ONS last January, the number of “zero-hour” employment contracts is no longer restricted to the fringes of the jobs market with an estimated 1.4-million people working without a guarantee of a minimum number of hours. Of note, nearly two thirds of people on zero-hour contracts are part-time workers compared with around a quarter of people not on them. The ONS plans to produce a future report on this subject in the summer of 2014 and it will release its findings by the end of the year.
To suggest Carney is in a pickle may be the understatement of the year. Consumer spending and the household market are the drivers of economic recovery and not business investment and global trade. Carney’s unusual suggestion that “we need to see real growth in every sector and in the current level of wages” to ensure the economic recovery that began last year is sustained has left investors wondering if this is the new indicator and not falling unemployment.
Just as the British economy needs to diversify so too the recovery needs to broaden regionally across the U.K. According to independent research firm The Work Foundation, jobs growth has been spectacular in London and parts of Southern England but significantly less so in other parts of the country.
In any event, Carney has repeatedly promised any interest rate hike will be gradual, limited in scope, and it will be communicated accordingly to investors, businesses, and consumers in advance of any move.
This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.