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BoE could have delayed interest rate rise

02 Nov 2017

Linda Yueh on why the Bank of England might have waited until spring 2018

 

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The Bank of England (BoE) had several reasons to delay a rise in UK interest rates until spring 2018, according to a London Business School (LBS) expert. 

On November 2, the BoE increased the rate from 0.25% to 0.5% as predicted by several economists. The first rise in nearly 10 years comes at a time when Britain is experiencing low unemployment and stable economic growth. 

But Linda Yueh, Adjunct Professor of Economics at LBS, said that the BoE had cause to wait a few months before taking action. One of them was inflation being above the bank’s 2% target, with the figure expected to rise beyond 3%. 

“The bank discounts inflation caused by weak sterling,” she said. “The pound had fallen considerably after the EU referendum last June. When the pound is weak, imports are more expensive so that raises the price level of the economy. Since the currency fluctuates – and sterling has already regained some of its value – the bank doesn’t act on its movements. It tends to ‘look through’ such inflation.”
 
Yueh added that with wage growth stagnant, the BoE could have held off from increasing interest rates. Consumer debt was another reason for a delay. British credit card debt amounts to £200 billion – rising 10% since this time last year – with the BoE concerned that up to £30 billion will never be repaid. 
 
“If interest rates were to rise, that could lead to more defaults,” Yueh said. “Of course, waiting a few more months wouldn’t lead to a significant difference in the consumer debt load. But giving plenty of warning about the impact of higher repayment costs may forestall further accumulation of debt and allow those who are indebted to plan accordingly.”
 
Brexit may also have led to a delay in raising interest rates. Yueh said that the BoE could have maintained the status quo to give banks time to develop a contingency plan for shoring up the UK financial system in case there was no Britain-EU deal by March 2019. 

However, Yueh warned that it took banks years to implement new plans. In the meantime, some of them could decide to move jobs out of London, which would likely affect the UK economy. 

“That could lead the BoE to wait for a few more months until next spring before raising rates,” Yueh said. “It’s also because central banks prefer to not have to reverse themselves – once they raise rates, they want markets to expect and plan for more rate rises and not wonder if rates will be cut again. 

“Some central bankers disagree with this approach. They argue that should rates need to be cut again because the economy needs help, then it’s not problematic to reverse the direction of the rate cycle. But the BoE has tended to move consistently in one direction.”

 

 

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