BOE Rate Rise Points to Interest Rate Normalization

The Bank of England’s recent decision to increase U.K. interest rates by 25 basis points highlights the fact that shrinking output gaps and tighter labor markets are causing central banks to move toward interest rate normalization.

According to a report from Fitch Ratings, the Bank of England is looking to tighten policy slowly. The bank said Thursday that its Monetary Policy Committee voted seven to two to increase the bank rate to 0.5%, reversing the cut made last August following Brexit. The last rate hike was made in July 2007. The bank also left the stock of bonds purchased through so-called quantitative easing unchanged.

“We think another increase is unlikely in the next 12 months, given the impact of Brexit uncertainty on the outlook for investment,” Fitch analysts said. The ratings agency said the bank’s decision doesn’t change its U.K. growth forecasts, “…which see a net trade boost partially offsetting slower domestic demand this year, enabling real GDP to rise by 1.5%, before slowing to 1.3% next year. But it remains to be seen how firms and households adjust to a shift in the monetary policy stance after such a long period without a rate rise.”

The bank’s decision underscores how tighter labor market conditions, with U.K. unemployment at a 42-year low, as well as concerns about harmful supply-side affects from Brexit, have decreased the acceptability for higher-than-expected inflation. Inflation grew to 3% in September, in part, as a reaction to a weakening sterling.

“As output gaps close, central banks around the world are generally refocusing on policy normalization,” Fitch analysts concluded.

– Nicholas Stern, managing editor

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