UK Rate Hike Likely Before End of Year

The UK economy put in a very solid performance last year. Recent GDP data for the final three months of 2014 showed that the economy grew by 0.5% in the quarter, writesOliver Mangan Chief Economist at AIB.

While this was slower than the 0.7% recorded in the third quarter, it marked the eighth straight quarter of growth.For the full year, the economy grew by 2.6%, a seven-year high. It represented an acceleration from the 1.7% growth rate achieved in 2013. The data for the fourth quarter showed that services output was once again the key growth driver of the economy, increasing by 0.8% and accounting for all of the rise in GDP.

Retail sales figures show that the domestic economy and, in particular consumer spending, remains a key factor in the economy’s good growth performance. Retail sales had their best quarter since 2001, increasing by 2.2% in the fourth quarter for a gain of 5% on a year-on-year basis.

The solid growth in the economy has brought about a marked improvement in the labour market. The economy continues to create jobs. In the three months to November, employment increased by a yearly 1.7%. The positive trend in employment is helping to push the jobless rate lower. It fell to 5.8% in November and unemployment is expected to continue falling in the coming months.

Despite the ongoing solid performance of the labour market and the economy as a whole, inflation has been very subdued. Declining oil prices have contributed to this, with the CPI rate falling to 0.5% in December, a 14-year low. However, wages are now starting to pick up, with growth in average weekly earnings accelerating to 1.7% year-on-year in November from less than 1% earlier in the year.

Meantime, there are some signs that the UK housing market may have peaked, with house price growth slowing in recent months. In terms of transaction activity, while mortgage approvals increased in December, this was their first increase in six months. Overall, though, an improving labour market, good readings from leading activity indicators, easing inflationary pressures, as well as a pick-up in wage growth, all suggest that the UK economy will continue to show solid growth.

Nonetheless, the economy is still facing some headwinds, including high household debt levels and ongoing fiscal tightening as well as soft global demand, especially from the eurozone, its main trading partner. However, despite those concerns, the UK economy is likely to expand by around 2.5% again in 2015, aided by a continuing very accommodative monetary policy.

At the January Monetary Policy Council meeting of the Bank of England, there was a unanimous decision to leave interest rates unchanged at 0.5%. The minutes from this meeting noted that in the view of all members, the outlook justified “maintaining” its current policy stance in light of concerns that the current low inflationary environment could become “entrenched”. However, two members who had previously voted for a rate hike, said their decision was “finely balanced”.

The generally more cautious tone from recent MPC meetings has seen markets scale back their expectations for UK rate hikes. UK rates are now expected to rise to just 1% by end 2016 from 0.5% at present. Last summer the expectation was that they would rise to over 2%. Furthermore, the start date for hiking rates has been pushed out to 2016 from the middle of this year. However, given the continuing solid growth performance in the UK economy, marked down trend in unemployment and signs of a pick-up in wage growth, we would maintain that the BoE could still hike before year end.

In fact some MPC members, including Governor Carney, have warned markets about being too sanguine about the possibility of UK rate hikes. This week’s Inflation Report from the BoE will be interesting reading in this regard.

Source: Irish Examiner February 10th 2015