Interest rate rise: keep calm and carry on
The Bank of England increased interest rates today for the first time in a decade. The Monetary...
Now that we have had some time to digest the UK’s collective decision to leave the European Union, what can we say about the prospects for the UK’s economy over the next 12 months?
Mike Amey, managing director of PIMCO, which is rated an Elite Provider for bonds, gives his view on the prospects for UK growth and inflation in the next 12 months.
“Our expectation is that growth will fall to around 0%, or slightly above, over the next 12 months, based upon a material slowdown in business investment, some easing in consumer spending and little change in either fiscal policy or the contribution from net trade.
“Also, we would expect consumer price inflation (CPI) to rise to 2% by mid-2017, as the impact of weaker sterling is reflected in import prices. While there are risks around this forecast, not all of those risks are negative. Certainly there is scope for a more material fall in business investment or consumer spending than we are expecting, but there is also scope for some form of fiscal stimulus from the government and Bank of England.
“Business investment had already shown some weakness ahead of the EU referendum on 23 June, and we would expect a further slowing to a -5% to -10% annual rate over the next 12 months, in line with some of the weaker periods in the decade prior to the financial crisis.
“At around 10% of gross domestic product (GDP), this will take around 0.5% to 1% off economic growth. Arguably harder to gauge will be the hit to consumer spending and, given that it generates around two-thirds of GDP, this will be an important determinant of the magnitude of the slowdown.
“Our expectation is that household consumption will slow by around 1%, which would be materially weaker than the pre-global financial crisis period.”
“Meanwhile, thinking about the path of inflation, the 11% fall in the trade-weighted sterling index should add around 0.75% to core inflation in the next 12 months. Core inflation is currently 1.2%. The headline CPI rate will converge to the core rate, as the effect of the drop in energy prices falls out of the annual number, and this should mean that headline CPI rises from its current rate of 0.3% to the 2% target by mid-2017.
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“Again, there is substantial uncertainty about how much of the fall in sterling gets passed into the CPI, but we have used prior relationships that indicate that a 10% fall in sterling typically adds 0.5% to 0.75% to headline CPI in 12 months’ time. Crucially, this will only take CPI back to the Bank of England’s long-term target rate and, as such, will not prove an impediment to monetary stimulus in the months ahead. In other words, it wouldn’t stop the Bank of England from keeping interest rates low, if necessary.
“Given the weak growth profile, we expect the Bank of England to cut official rates toward (but not below) zero and, thereafter, consider restarting its quantitative easing programme if further stimulus is deemed necessary. This should support UK government bonds and keep sterling on the back foot.”