The value of sterling has dropped after a trio of officials on the Bank of England’s Monetary Policy Committee (MPC) indicated that UK interest rates are likely to be cut in the coming months.
Outgoing governor Mark Carney told FTAdviser’s sister publication the Financial Times last week (January 7) that the central bank could cut interest rates to support economic growth.
Data released this morning (13 January) by the Office for National Statistics showed UK economic activity contracted by 0.3 per cent in November, the month prior to the general election, to reach a year-on-year growth of 0.6 per cent.
This and the trio’s remarks have led to sterling falling 0.7 per cent this morning and more than 2 per cent since the start of the year.
Mr Carney warned in the next economic downturn there would be limits to how much politicians can rely on central banks to boost economic growth, as most of the tools, including rate cuts and quantitative easing, are already being deployed.
But he said with the UK base rate presently at 0.75 per cent there was some scope for the UK central bank to cut rates.
UK interest rates are presently higher than those of the Eurozone and Japan, where interest rates are negative.
Mr Carney leaves his role as governor in March to be replaced by Andrew Bailey, the current FCA chief executive.
Jonathan Haskel, another member of the MPC, which sets interest rates at the Bank of England, said in a speech to the Resolution Foundation at the end of December that current economic indicators pointed to the UK economy and inflation slowing.
He said: “The global economic outlook has weakened materially since 2018, turning gloomier and less supportive of UK growth.
“This was mainly the result of heightened uncertainty combined with a slower pace of recovery in the Euro Area and, in particular, the escalation of US-China trade tensions.”
He said in the immediate aftermath of the UK voting to leave the EU the fall in the value of sterling had created a sharp increase in inflation to above 3 per cent, much higher than the inflation rate in other countries.
At first the higher prices did not, Mr Haskel said, translate into slower economic growth, as people maintained their consumption by reducing the amount they saved.
But while the UK savings rate fell to less than 3 per cent at the time, the lowest level since 1963, it has since risen to 4.5 per cent, and more recently to 6.75 per cent in the final quarter of 2019. The long-term average is 8 per cent.
If individuals are saving more and consuming less this means demand in the economy is weaker and so economic growth falls while consumption is also falling, meaning the rate of inflation falls.
Cutting interest rates makes saving cash less attractive, and so may encourage more spending, boosting growth and pushing inflation upwards. The current UK inflation rate is forecast to be below target at 1.5 per cent.
The Bank of England’s remit is to achieve inflation of around 2 per cent a year, if it falls materially below that level, then cutting rates to push inflation upwards towards the target would be the expected course of action.
A third member of the committee, Gertjan Vlieghe said he would favour an interest rate cut if economic data does not improve quickly.
He told the Financial Times on the weekend (January 12) that he expects there to be a pick up in UK economic activity as a result of the greater level of certainty as a result of Conservative party general election victory, but if this doesn’t happen, then rates will need to be cut.
He said it will be obvious by the end of January whether this has happened or not.
By David Thorpe
Source: FT Adviser