British households should prepare for an interest rate rise within a year if the economy continues to be buoyed by a booming jobs market and strengthening global recovery, the Bank of England has signaled.
Policymakers kept interest rates on hold at a record low of 0.25pc on Thursday, as they said stronger exports and investment would help to offset slower growth in consumer spending amid a squeeze in real incomes.
External policymakers Michael Saunders and Ian McCafferty reiterated their call to raise rates to 0.5pc as the Monetary Policy Committee (MPC) voted by a majority of 6-2 to keep rates unchanged.
Bank staff trimmed their growth forecasts to 1.7pc in 2017 and 1.6pc in 2018, down from a May projection of 1.9pc and 1.7pc respectively.
Mark Carney, the Bank’s Governor, said the pressure on households from higher inflation would start to ease at the turn of the year.
He also indicated that interest rates might have to rise even if the current rate of UK growth remains modest
He said, “prolonged low investment” and weak productivity meant even a slight uptick in demand could be enough to warrant interest rate hikes to keep a lid on inflation.
Mr. Carney described the financial system as “rock solid”. He added that UK households remained in a “position of strength”, with unemployment now at a 40-year low.
The Governor also predicted that the City of London will continue to thrive in a post-Brexit world as he said the financial sector could double in size over the next two decades.
He told the Guardian that the size of the sector had “many strengths” as he signaled that Brussels’ attempts to lure activity away from the City would not threaten London’s status as one of the world’s pre-eminent financial capitals.
“If the UK financial system thrives in a post-Brexit world, which is the plan, it will not be 10 times GDP, it will be 15 to 20 times GDP in another quarter of a century because we will keep our market share of cross-border capital flows.”
He said policymakers would need to “keep the focus” on maintaining post-crisis reforms as he warned of the dangers of watering down regulation.
Speaking at the launch of the Bank’s quarterly Inflation Report, he also said the current squeeze on household finances from higher inflation would start to ease at the turn of the year.
“We think we’re in the teeth of this right now. Over the course of the next couple of quarters it will continue to feel like this, but as we move into the new year, we’ll see inflation start to come down and household incomes start to move out of this real income squeeze.”
Financial markets currently expect two-quarter point interest rate rises by the start of the next decade, with the first priced in for the third quarter of next year.
The minutes of the August meeting said: “If the economy were to follow a path broadly consistent with the August central projection, then monetary policy could need to be tightened to a somewhat greater extent over the forecast period than the path implied by [markets].”
The eight members of the MPC expect growth in the first quarter of 2017 to be revised up to 0.4pc, from a current official projection of 0.2pc. The quarterly pace of growth for the rest of the year is forecast to remain around 0.3pc.
Officials left their projections for inflation broadly unchanged as they reiterated that price growth was still likely to peak at around 3pc in the autumn.
Policymakers trimmed their unemployment forecasts to 4.4pc for 2017, from a previous projection of 4.7pc.
The unemployment rate is set to remain around 4.5pc for the rest of the decade, which is the rate at which policymakers expect will start to push up pay.
Separate survey data on Thursday showed Britain’s powerful services sector accelerated a touch in July, raising hopes that the economy overall is now gathering steam.
Businesses reported accelerating growth in new orders from customers and said they are increasing the pace at which they take on extra workers to cope with the demand, according to IHS Markit.
While earnings are expected to rise steadily over the next few years, the Bank believes more companies will choose to boost margins rather than staff salaries over the next three years, resulting in more modest pay growth.
A strengthening global recovery is also expected to push up business investment and exports, even as uncertainty surrounds the outcome of Brexit negotiations.
However, Mr. Carney highlighted that investment levels were now forecast to be 20 percentage points below its forecast before the Brexit vote by the end of the decade.
He said policymakers’ main assumption of “a smooth transition to a new economic relationship with the EU will be tested”, adding that bosses across the economy had made it “pretty clear” that an implementation period was in the best interest of the UK and EU.
Bank policymakers announced on Thursday that a term funding scheme (TFS) designed to offset the hit to bank margins from last August’s cut in interest rates would end as planned in February 2018.
It has already taken steps to try to rein in lending by reversing measures to free up cash for commercial banks to lend in the wake of the Brexit vote.
The TFS provides cheap funds to commercial banks for four years, which can borrow an amount equal to 5pc of their existing loan books, plus additional allowances depending on how much they lend to the real economy.
If net lending is positive between June 2016 and end of December 2017, they are only charged the Bank Rate.
Samuel Tombs, chief UK economist at Pantheon Macroeconomics, said commercial lenders had borrowed “enthusiastically” from the initial £100bn pot, as the same funds raised on wholesale markets or retail investors would cost commercial banks around 100 basis points.
Philip Hammond, the Chancellor, agreed to increase the total money available through the TFS by £15bn to meet projected demand.
Commercial banks have already drawn £78bn from the scheme since it was launched.
The MPC said that despite the Bank’s other measures to tighten credit in the economy, interest rate rises were likely to be needed to prevent it from overheating.
“The Committee judged that given the assumptions underlying its projection including the closure of the drawdown period of the TFS, and allowing for the effects of the recent prudential decision… Some tightening of monetary policy would be required to achieve a sustainable return of inflation to the target.”