Interest rate: 'core' inflation high rekindles hike hope
Hopes that interest rates will rise in the UK in the near-term future were given a boost on Tuesday after official data showed that prices rose marginally faster than forecast in July. In addition, 'core' inflation (not including more volatile changes) hit a five-month high, adding to a sense that underlying price pressures are growing.
Figures from the Office for National Statistics reveal prices across the country rose 0.1 per cent in July compared to the same month last year, the BBC reports, beating expectations of no growth on the back of a continued fall in the oil price. An underlying measure of prices, which strips out goods and services prone to erratic movements (such as energy and food), rose 1.2 per cent, the fastest pace since February.
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Clothes prices, which fell at a slower rate than predicted, were said to be primarily responsible for the headline increase, while rents and flight costs saw significant hikes which contributed to the higher underlying rate.
The pound rose immediately following news of the price increase, trading up more than 0.5 per cent against the dollar and 0.6 per cent against the euro. The Guardian says traders are betting that the news will signal a move to raise rates sooner. An increase would hit mortgage holders on variable rates, but be welcomed by investors and savers who are currently struggling to generate returns without taking on excessive risk.
The rise in core inflation echoes the sentiments of one of the Bank of England's rate-setters Kristin Forbes, who said faster wage growth was increasing "underlying cost pressures" that could, if left unchecked, prompt an inflationary spiral. She said rate rises took one to two years to be fully felt, so a decision would have to be "preventative".
Some, though, suggest that the underlying rise in inflation is not yet an indication that price rises, even discounting volatile energy and transport costs, are on their way back to the bank's two per cent target.
Interest rate: 'preventative' rise may defy low inflation
Inflation probably remained at zero again in July and unemployment may be creeping back up from recent lows, but the Bank of England's rate-setters may still take "preventative action" and increase interest rates sooner rather than later.
Writing in the Daily Telegraph Kristin Forbes, an American economics professor who has been an external member of the bank's Monetary Policy Committee for around a year, says that signs that a "solid recovery is finally here" at a time when prices are stagnating make it "tempting to enjoy the good news" and hold rates lower for longer. But she warns that if the economy fails to move from its "comfortable spot in the sun" it may get "painful sunburn" that could "spoil the… holiday".
The more than half of mortgage holders currently on variable rates or locked into a deal without a sufficiently long-term horizon have enjoyed a six-year period during which rates have remained at a record low 0.5 per cent, pushing mortgage affordability to an all-time high. Those with cash savings, however, have suffered and Forbes warns of "distortions" that also affect individual and institutional investors starved of yields on safer investments.
Put simply, she says that rapid wage growth which has averaged 3.3 per cent over the past three months – and that may even be "understated" due to the effect of new additions to the workforce in low-income industries – is contributing to a "growth in underlying cost pressures" which is "obscured" by low inflation, itself mainly a result of external factors such as falling fuel prices. She adds that the 'lag' impact interest rates of up to two years means a rise must happen "well before" inflation hits the bank's two per cent target.
Most economists are currently predicting a rise early next year, but others have been calling for rates to stay low beyond next year. The Observer's leader this week suggests that signs that low inflation will persist globally "for years to come" could yet see Mark Carney finish his five-year term as the bank's governor in 2018 "without once raising rates".
Interest rates: jobless rise adds to case for hold
New jobless figures have provided another indicator the case for an interest rate rise is easing.
Official data published on Wednesday showed a second consecutive quarterly increase in unemployment across the UK.
The BBC notes there was a 25,000 rise in the number of people officially unemployed and looking for work to 1.85 million, while the number of people in work fell by around 63,000 to 31.03 million.
The jobless total has now risen throughout the first half of the year and, with the Bank of England reporting companies are finding it harder to recruit, the Office for National Statistics raised the "possibility" that the "jobs market is levelling off".
Wage growth also recorded what the Daily Telegraph describes as a "shock" fall, with annual growth including bonuses falling from 3.2 per cent to 2.4 per cent. It suggests the weakening employment picture combined with global economic turmoil emanating from China have "pushed back expectations of an interest rate rise well into next year".
Others suggest the numbers are not as bad as they first appear. The Financial Times points out the employment rate remains close to its record high of 73.5 per cent, with the unemployment rate steady and still low at 5.6 per cent.
Wage growth excluding bonuses, the measure most watched by the Bank of England, was also steady at 2.8 per cent, implying strongly improving cost of living since inflation remains close to zero.
It says the data show people worked 0.2 per cent fewer hours on average in the second quarter of this year, while the economy grew 0.7 per cent. This implies workers became almost 1 per cent more productive and is being taken by many economists as a sign the balance of growth is shifting away from employment to productivity. John Hawksworth, PwC’s chief economist, said this would be "good news if it makes the upturn more sustainable in the long run".
This still may not increase the chances of an early rate rise, as increasing productivity allows employers to pay more without increasing prices. But if the economy is seen to be more sustainable it does remove some of the risks of an early rise, which could prompt action if other factors begin to drive inflation.
Interest rates: why they could rise sooner than expected
An interest rate rise was kicked into the long grass last week – or at least, that was the view of many.
In fact, the strong vote for a hold should not be taken as a "clear cut" position, according to one member of the Bank of England's rate-setting committee.
David Miles, a professor of financial economics at Imperial College Business School in London and outgoing member of the Monetary Policy Committee, told Bloomberg he came very close to voting for a rise and there "wasn’t a compelling clear-cut case one way or the other".
While his comments have little direct consequence given his six-year tenure on the panel is at an end, it does signal a shift in the tenor of discussions among rate-setters. Having never voted for an increase during his six years, Miles could hardly be described as a hawk, either.
Only one member, noted hawk Ian McCafferty, voted for a rise in August, less than the two to three members many had expected. But a widely held view was that the accompanying inflation report painted an uncertain picture of future trends and the circumstances for an increase could come about quickly.
Miles's comments will further the view that short-term trends which are subject to change are driving decisions. The professor said a fall in commodity prices that brought near-term downward pressure on inflation and "ambiguous signals" from the labour market just about tipped the balance.
Philip Shaw, chief economist at Investec Securities in London, told Bloomberg the comments suggest the committee as a whole could be placing "a fair amount of weight on trends in unemployment over the coming months".
One of the key arguments against a rise is the impact on homeowners with a variable rate mortgage. The BBC says Miles indicated he did not think "alarm bells" were ringing and that new regulations mean "the risk of all this playing out badly is much lower now than at any time in the past".
Interest rates: when will they actually start rising?
Interest rates were not increased yesterday – they were never going to be. A stronger vote for continuity than had been expected is being widely interpreted as a sign that a rise is further off than some thought, which is bad news for savers but good for many mortgage holders.
So when will rates actually rise and by how much?
The BBC's Robert Peston says data in the Bank of England's inflation report are based on the assumption the first hike in rates will come "in the first four months of next year", broadly in line with revised market expectations. That is not to say it will do so – governor Mark Carney has said it would be "foolish" to predetermine timing – but it is the basis for current economic forecasts.
He adds that while the interest rate "could rise a bit faster next year" than previously thought, the Bank is still only modelling a gentle rise of 0.25 per cent initially and an eventual rise of 0.5 per cent by the end of 2016. If this was passed on immediately and in full by banks – not a given as variable rates have not fallen as much as some had expected – "mortgage rates would rise by 0.5 per cent".
There is, though, considerable uncertainty in the report. Writing in The Times, Philip Aldrick says the Bank is a "bystander" to the main issues that will hold inflation down for longer and at zero in the coming months, namely weak commodity and food prices. But it is keen to respond to domestic factors which "drive internally generated inflation".
While the Bank's data showed an improvement in productivity coinciding with strong wage growth, which implies 'slack' in the economy is being used up, unemployment has also risen and companies are reporting a "skills mismatch" which is making it "increasingly difficult to recruit new employees". If they have to pay more for less productive labour, costs – and therefore prices – will rise.
"Slack may be vanishing quickly," Aldrick adds. "If jobs data bears this out, that rate rise will come closer."
Writing in The Guardian, Nils Pratley notes that in recognising these issues Carney has become "increasingly hawkish on rates" and signalled again the decision may come into "sharper relief" at the turn of the year, implying an early 2016 move. "But it’s also possible that the real world", in the form of for example "a blow-up in Greece [or] a steeper slowdown in China", could change that.
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