Bank of England Quarterly Inflation Report –  14th May 2014

Today, the Bank of England (BoE) released its latest quarterly Inflation Report, which updates its projections for inflation and the wider UK economy. Overall, the report did not make significant changes to either the Bank’s inflation forecasts or its expectations for UK economic growth. It did, however, reflect on market expectations that the UK interest rates might rise before the end of the year.

Furthermore, the UK monthly labour market report, which outlines unemployment in the UK as well as other labour statistics, such as wage growth was issued and confirms:

• UK labour market remained strong with unemployment dropping from 6.9% to 6.8% in the three months to March, which was in line with market expectations. The number of people in employment rose to 30.43 million, the highest level since records began in 1971.
• Wage growth in March came in significantly below expectations at 1.7% (year on year). Markets had been hoping for a 2% rise, with much of the shortfall being generated by weaker-than-expected private sector growth. The BoE, however, forecast that wage growth will begin to rise towards 2.5% at the end of the year.

Previously, some were predicting that the Monetary Policy Committee (MPC) would use the labour report to confirm interest rate expectations currently built into market prices, which see the first rate rise happening between November 2014 and February 2015. This is not what happened.

The Bank’s forecasts do now suggest that inflation will be slightly above target in two-to-three years’ time, on the assumption of unchanged policy. The implication is that rates would need to rise, modestly, in 2015 for the Bank to have a better than 50-50 chance of staying on target. That is a change from the last Inflation Report, in February, but not a very consequential one. Literally no-one expects the base rate to remain at its current record low of 0.5% until 2016, and even the forecast on unchanged policy only suggests that the CPI measure might rise to just under 2.4%.

Investment Implications
Investors are right to prepare for the first rate rise in the UK, which currently looks set to happen before the first official interest rate rise in the US. But today has shown that the markets have got a little ahead of themselves in pricing in a rate rise at the turn of the year. We don’t think the MPC would hesitate to raise interest rates before the General Election in May 2015, if the economic data seemed to demand it. But neither is it going to be forced down this path by the sheer weight of market expectations. It’s worth noting that the Bank’s governor, Mark Carney, also issued a timely warning to investors regarding the current very low levels of market volatility. As the economy – and policy – start to move towards normality, he said investors should expect volatility to get back to normal as well.