Weale and McCafferty vote to raise rates to 0.75%; Sterling rebounds from four-month low, UK government bonds fall; dissent ends record period of unanimity on MPC; economists say other officials may be slow to follow suit
Bank of England policymakers broke ranks over interest rates for the first time in three years this month, when two unexpectedly voted to tighten policy and revived speculation about a 2014 rate hike.
Former academic Martin Weale and business economist Ian McCafferty both voted to raise interest rates to 0.75% from 0.5%, according to minutes released yesterday of the nine-member Monetary Policy Committee’s meeting on August 6-7.
Their dissenting votes ended the longest period of unanimity in the MPC’s 14-year history. Sterling rebounded from a four-month low and government bonds fell as expectations for an early rise in British interest rates were revived.
Last week, the BoE slashed its forecasts for wage growth for 2014 and said it did not want to raise rates until stronger wage rises looked imminent — a view shared by the majority of the MPC in yesterday’s minutes.
But Weale and McCafferty believed recent declines in unemployment suggest wage growth could accelerate, and that the economy was running at close to capacity and rates needed to rise now.
“Since monetary policy ... could be expected to operate only with a lag, it was desirable to anticipate labour market pressures by raising the Bank Rate in advance,” they said.
They added that an early rate rise would help ensure that future increases were gradual.
Weale has a record of hawkish positions on monetary policy. He backed rate rises in 2011 and opposed introducing forward guidance in August last year on the grounds that it lacked strong enough safeguards against high inflation.
McCafferty joined the MPC in 2012 from the Confederation of British Industry. He had previously raised concerns about the slow growth in British productivity since the financial crisis, which could push up inflation.
Some economists doubted that other members of the MPC would soon follow suit. Unlike policymakers at some other central banks, MPC members at the BoE have sometimes dissented against their colleagues for months.
But three members of the MPC — chief economist Andy Haldane, deputy governor Minouche Shafik and external member Kristin Forbes — have been on the committee for less than three months, so may be reluctant to go out on a limb.
“Historically, dissenting votes have signalled that a policy change is imminent no more than half of the time,” said economists at Fathom Consulting.
Moreover, economic data has swung against an early rate rise since August’s vote. Consumer price inflation has dropped further below target to 1.6%, and wages fell year-on-year for the first time in five years — albeit partly due to one-off effects.
“We do not believe that a November 2014 Bank Rate hike is materially more likely following these minutes,” said Ross Walker, an economist at RBS who had correctly forecast the vote split. “We continue to regard Messrs Weale and McCafferty as outliers not bellwethers - at the margin, our confidence in this view is reinforced following yesterday’s CPI.”
Most of the MPC said the inflation outlook was too weak to justify raising rates from the record low reached in March 2009 in the depths of the financial crisis, even though Britain looks set this year to enjoy its strongest growth in a decade.
“A premature tightening in monetary policy might leave the economy vulnerable to shocks, with the effectiveness of any further necessary stimulus being limited by the effective lower bound on Bank Rate,” the majority of the MPC said.
A rate rise could also hurt heavily indebted households and push sterling higher, damaging exports, which are already being held back by economic weakness in Britain’s main markets on continental Europe, the MPC said.
Mortgage lender Halifax said yesterday that a third of borrowers said they would struggle to pay an extra £100 ($170) a month in interest.
The MPC said it expected the case for a rate rise to strengthen as the economy recovered further.
“This, along with a continued improvement in credit conditions, would in time diminish the need for such a low level of Bank Rate,” the minutes said.
Meanwhile, Bank of England policymakers have started to discuss how to end crisis-era measures which pegged overnight money market rates to the central bank’s official interest rate, according to the policy minutes.
The central bank’s money market operations are crucial to the way it implements monetary policy. The BoE said its existing framework, which was introduced in 2009, could continue to be used in the “near term” to implement any increases in the Bank Rate, its official interest rate.
But it said it expected to give more information about changes in the coming months. Changes would also be needed once a decision had been reached about the future of the BoE’s £375bn pounds of government bond purchases, which it bought between 2009 and 2012 with newly created money to spur the economy.
Since 2009, the BoE has paid interest on all commercial banks’ reserves held at the central bank at the official base rate, currently 0.5%, to keep money market interest rates in line with the base rate.
Members of the BoE’s rate-setting Monetary Policy Committee held an “initial discussion” about changing the so-called sterling monetary framework at their August meeting, minutes of the discussion showed yesterday.
A BoE spokeswoman said a review would be handled by Minouche Shafik, the new deputy governor for markets and banking.
Moyeen Islam, fixed income strategist at Barclays, said the length of time needed for the review meant that the BoE would keep paying interest on all reserves for around six to nine months into an interest rate hiking cycle.
Economists and financial markets do not expect the BoE to start raising interest rates until the start of next year.
“This is the first time the Bank to my knowledge has explicitly said they intend to maintain effectively a floor system of reserves in the early part of the rate cycle,” Islam added.
Following the review, the BoE could return to its pre-2009 system of “reserves averaging”, under which banks chose a monthly target for reserves held at the central bank.
If they undershot or overshot reserves, they faced penalties, giving them an incentive to instead use money markets for managing their short-term liquidity needs.
The BoE suspended reserves averaging in 2009 because the introduction of quantitative easing asset purchases meant the supply of reserves reflected more the size of the stimulus, rather than demand from banks.
Since then, banks have not been required to set targets for reserve balances.
Paul Fisher — who until recently was a member of the MPC responsible for money markets — said in 2011 that a return to reserves averaging was the most likely option.
