UK inflation tolerance can off-set BoE interest rate path

In August, the UK central bank cut interest rates to stimulate the economy with a potential for further reduction. But, the economic situation has improved since then. Considering the low tolerance of bank officials toward above-target inflation, BoE interest rate path could be up for a change.

13 December, AtoZForex – Almost two-thirds of analysts surveyed by Bloomberg anticipate the Bank of England (BoE) to increase its benchmark from a record low level. Since policy makers are attempting to prevent inflation from exceeding bank’s 2 percent target during the second quarter of the forthcoming year. In November, consumer-price growth reached 1.1 percent which is the fastest pace in two years.

BoE interest rate path

The neutral stance of the central bank is a result of the pressures created by the Brexit referendum. On Thursday, the BoE will release its most recent policy decisions. Hence, central bank's Governor Mark Carney along with other officials will need to provide insights into how they plan to balance supporting growth and monitoring inflation.
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There was a consensus among economists surveyed that the rates will remain unchanged at 0.25 percent during the meeting. The same is for the asset-buying target at £435 billion of government securities plus £10 billion of corporate debt.

The current position of the UK central banks differs from its fellows. As markets anticipate the Federal Reserve (Fed) to increase rates this Wednesday. While, the European Central Bank (ECB) decided to prolong its quantitative easing program for additional nine months, until the end of 2017. According to Asmara Jamaleh, an economist at Intesa Sanpaolo SpA, the time and the direction of the next BoE move will depend on the Brexit exit talks.

"The next year will be one of transition and so monetary conditions will need to remain accommodative. The first rate hike could come in 2018. The Bank of England can afford to accept higher inflation for some months, but not forever."

A possibility of above-target inflation

In November, the inflation rate went up to 1.1 percent. With projections indicating a recovery in 2017, officials left the guidance that indicated a possibility of lower rates before the end of the year.

Traders are expecting an increase rather than a decrease, priced into futures contracts from June 2017. The same is for the UK households who are expecting a rate increase by November.

Although the BoE cut rates in August to stimulate the economy following the Brexit vote, the policy makers have had to review growth forecasts for 2016 and 2017 and concentrate on increasing prices. According to Mark Carney, central bank’s officials have a limited tolerance for above-target inflation. Yet, the BoE projections show that offsetting the impact of sterling on inflation within three years would require an aggressive tightening. Such policy measures would hit the economy and foster unemployment.

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