The latest Bank of England Inflation Report includes a chart showing a substantial overshoot in inflation, assuming policy remains unchanged.
On the face of it, this is a clear signal that the Monetary Policy Committee believes interest rates need to rise at some point.
Indeed, during the press conference which followed publication of the report, Bank of England governor Mark Carney stated that the timing of a hike was “closer than in May”.
The famous fan charts suggest that this is more likely to happen in 2016, rather than by the end of this year.
The minutes of the August MPC meeting show the committee is divided on the timing of policy tightening, with one member voting for an immediate increase.
There had been widespread expectations that two or more members would vote for a hike at this stage.
Together with an Inflation Report which appeared to sanction a rate hike in 2016 rather than 2015, this news was taken as dovish by financial markets – gilts rallied and sterling sold off.
There is still a reasonable chance of a hike before year end, however a number of developments would have to materialise. The pace of UK economic growth would need to remain robust, with wage growth continuing to rise by more than the MPC expect.
A rate increase by the US Federal Reserve would also create more favourable conditions for a similar move by the Bank of England, taking upward pressure off sterling. Whether a rate rise comes this year or next is less important than the pace of any increases thereafter.
We still expect only a very modest increase, given the low level inflation and the sensitivity of households to a rise in the cost of debt.
