By Stephanie Flanders
Clearly, the next move in policy will be a rise in the official policy rate, which has remained at that record low for more than five years. Given the strength of the UK economy, the Bank of England (BoE) may well be the first major developed country central bank to take this momentous step. The financial markets are currently expecting this move in late 2014 or early 2015.
On the face of it, there would seem to be plenty of reason for the Bank to think about raising interest rates. Parts of the UK housing sector are looking increasingly frothy, with house prices rising 8.5% in the 12 months to March 2014, the fastest growth rate since September 2007, according to Halifax.
In addition, the International Monetary Fund has predicted that the UK will be the fastest-growing rich economy this year, with growth of 2.9%, suggesting that ultra-loose monetary policy is no longer necessary to protect the economic recovery. In the first instance, however, the Bank’s new financial policy committee has signalled that it would prefer to use measured to tighten lending requirements – and other “macro-prudential” tools – to address concerns about the housing market. The doves on the Monetary Policy Committee can point to the behaviour of inflation in justifying their decision to keep policy historically loose. The latest version of the Bank’s “forward guidance”, laid out in February, also suggested that the Bank would be reluctant to normalise monetary policy while there was still an ample amount of spare capacity in the economy.
The BoE’s primary mandate is to keep inflation close to 2%. In March, the UK inflation rate reached 1.7%, which is a four-year low and somewhat lower than the Bank forecast in February. The strength of the pound is likely to continue to put downward pressure on inflation for some time.
As long as wage pressures remain subdued, we expect the official policy rate to remain at a record low, well until 2015. Trying to predict the exact timing of a rise is a mug’s game. Instead, investors should take advantage of this period to diversify their portfolios and rebalance to cope with a rising rate environment.
Stephanie Flanders is chief market strategist for UK and Europe at JP Morgan Asset Management
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