In its inflation report published earlier this week, the Bank of England (BOE) announced that inflation may hit 5% by the end of the year. By 2013, the BOE sees inflation standing at around 2%, an upward revision from its former estimate of 1.6%.
With those upsized numbers, it’s only natural to expect the BOE to raise interest rates soon. But I think I’ll go out on a limb and say that even with an upgraded inflation forecast, a rate hike will likely come later rather than sooner. Lemme give you three reasons why I think so!
1. Weak sauce economy
You don’t need to be an economic genius to see that the U.K. economy has seen better days. Just last week we caught a glimpse of how cruddy things have gotten for its major industries. The manufacturing, construction, and services sectors all recorded contractions last month, printing red figures in their respective PMI reports.
Actually, concern over economic growth is the main reason the central bank has been holding off on rate hikes, even with stubbornly high inflation staring it in the face. It’s not that the central bank isn’t worried about rising prices, it’s that it’s worried MORE about hurting growth.
2. Rate spread
Raising the official bank rate now would have a rising inflation effect as commercial banks would then have to raise the LIBOR rates they charge each other to maintain the same income on the interest they charge. This of course, will in turn affect the end consumer as rates are raised on them, most likely stifling lending and growth.
King said he’d like to see the spread between bank funding rates and the official bank rate come down in the next couple of years, at which point, the economic environment may warrant an official bank rate hike.
3. Inflation persuasion
According to King, domestically generated inflation, the portion of inflation that comes from the U.K. itself, is actually “well below target.” This means that inflation is being propped up by other factors, such as rising commodities.
Tell me, do you think a rate hike in the U.K. will do anything to temper rising global commodity prices? I didn’t think so!
So then when can we expect the BOE to take rates up a notch?
Something tells me that the central bank won’t touch interest rates until the fourth quarter of 2011. With the economic outlook as cloudy as ever, I don’t see the BOE putting economic growth at risk with an ill-timed rate hike.
I wouldn’t be surprised to see the pound pop up if CPI comes out better than expected on Tuesday. After all, we all know how people love to speculate about rate hikes. But personally, I wouldn’t hold my breath for one.