London: Brexit, which prompted Mark Carney to cut U.K. interest rates for the first time in seven years in 2016, is now pushing in the other direction.
In a speech in Washington on Monday, the Bank of England (BoE) governor said while the decision to leave the European Union (EU) has slowed growth, it’s also cut the economy’s potential. That reduced “speed limit"—as he has described it—increases the chance of overheating and partly explains why the monetary policy committee (MPC) now says it may need to raise rates soon.
Carney’s speech, echoing the surprise statement issued by UK policy makers last week, underscores the complexity of the task facing the BoE as Britain attempts to extricate itself from the EU. Negotiations are deadlocked, leaving officials to navigate a process fraught with political uncertainty. Big question marks remain over migration, the labour market, trade and investment.
All of those have implications for the economy and monetary policy. Economic growth slowed in the first half of the year and inflation has accelerated to almost 3%. Carney’s comments add weight to the idea that above-target price growth is in fact becoming more entrenched and cannot be ignored, rather than being a short-term spike as a result of the fall in the pound.
Economists are slowing changing their rate calls since the MPC’s hawkish shift. In the latest Bloomberg survey, published on Tuesday, 11 now expect a hike in the fourth quarter of this year. That’s still a minority, though up from three last month, and the number may climb further as economists continue to tear up their forecasts.
The BoE expects price growth to remain above its 2% goal in the coming years and said on Thursday it may soon need to lift its benchmark rate from a record-low 0.25%. The bank, which hasn’t raised the rate in more than a decade, reduced it and restarted quantitative easing after the EU referendum last year.
Carney said leaving the EU will at least temporarily reduce the openness of the economy because any replacement deals with other trade partners will take time to be agreed and even longer to have an impact on the economy.
He used a French phrase to sum up this view—“reculer pour mieux sauter," or “stepping back in order to jump better."
The BoE governor also said there are global factors that could justify UK policy tightening soon. In his view, the case for such a move is reinforced by the possibility that global equilibrium interest rates may be rising, which means that monetary policy “has to move in order to stand still."
Some of Carney’s comments were interpreted as more dovish in the wake of last week’s MPC statement, reinforcing the view that the rate-hike cycle in the UK will be very shallow—or “limited and gradual," to use Carney’s phrase. The pound weakened as he spoke, dropping from a one-year high.
He said there remains “considerable risks to the UK outlook," noting how consumers, companies and markets respond to the Brexit process. He also said the economy will underperform the Group-of-Seven average through mid-2018. Bloomberg