Will the Bank of England be forced to raise rates this year?

Steven Bell, economist at BMO Global Asset Management comments on whether the Bank of England will be forced to raise base rates this year.

Mini housing boom and a spending boom

Last month we took a look at the UK housing market and noted that there were signs that a mini boom was emerging with both house prices and rents accelerating. The trend in retail spending has also been strong. This acceleration in UK domestic demand will no doubt have raised some eyebrows within the Bank of England’s Monetary Policy Committee (MPC) but they may have taken solace in the near zero rate of inflation and the impending severe squeeze expected to be announced in the emergency Budget next month.

Retail spending strong since 2013

Let’s look at the evidence. Retail spending was broadly flat between 2009 and 2012, since then the trend has picked up to a buoyant 4.6% a year. With this trend now in its third year, we can reasonably talk of a UK spending boom.

Inflation pressures are rising

The Bank of England is charged with controlling inflation, not retail spending. As headline inflation tumbled and wages remained subdued, they could take a relaxed approach to consumer spending. The wages picture has changed significantly. From 2011 until the middle of last year, wage growth averaged a very modest 1.3% a year. Since then it has picked up to 3.5% a year. The last three months has seen annualised growth of 4.5%. Rising wages boost inflation only to the extent that they exceed productivity growth. Yet great uncertainty surrounds the prospects for UK productivity growth. The Bank of England take the view that productivity will gradually rise back to the previous trend rate of growth. If so, the 2% inflation target would be consistent with wage growth of 3.5%. If they are being too optimistic on productivity, or if wages accelerate further, they risk accommodating a damaging rise in inflation which would ultimately require a hefty increase in interest rates and raise the risk of recession.

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