23 Mar 2018 3 min read

Carney’s critical conundrum


In November, the Bank of England decided not to go beyond reversing the 'insurance' rate cut it made following the EU referendum. Since then, however, the UK labour market has improved and inflation has remained stubbornly high. This presents the governor with a conundrum. Should he raise rates again soon or remain cautious and wait for the fog of uncertainty regarding the final Brexit deal to lift?


Back in November, the Bank of England (BoE) raised interest rates for the first time in over a decade. There was no surprise as BoE Governor Mark Carney had signalled his intentions to do so a couple of months earlier. But it was also generally thought that a November rate rise would be a one-off, or “one and done” as the city jargon termed it. 

Now, however, the conundrum he faces regarding Brexit and the state of the economy is becoming less pronounced; hence Carney’s contracting conundrum.

"It was generally thought that a November rate rise would be a one-off, or 'one and done'"

My inspiration for this article’s title came from Mario's marvellous medicine, in which my colleague James Carrick discusses the possible ramifications of central banks deciding to withdraw the monetary punchbowl.

While mainland European inflation has remained relatively contained, the BoE has recently had to contend with an annual increase in the consumer price index of more than 1% above its 2% target. In the main, this has been a function of the decline of the value of sterling that followed the June 2016 EU referendum. We think inflation will be slow to fall as stronger-than-expected UK economic growth, combined with a tight labour market and increasing wages, exert some upward pressure on prices.

"The Bank of England has recently had to contend with inflation of more than 1% above its 2% target"

In February, the BoE acknowledged the stronger economy, particularly regarding the short-term outlook. At the same time the bank indicated that inflation was likely to remain above target, with 2017’s partial recovery in the pound taking time to feed back into more moderate price increases. While Carney stopped short of naming specific dates, his language marked something of a shift from earlier signals. Instead, he implied that a faster pace of rate hikes than previously expected might be warranted.

Since then there has been further upward progress in wage growth and progress towards a Brexit transition agreement. And in the most recent BoE meeting minutes, two policymakers voted for an immediate rate hike, all but cementing a signal that a rate increase is coming in May.

"Our central view is that a 0.25% hike in the base rate is likely in May, as well as November"

Another hike in November also seems to be on the cards given the persistently above-target inflation, although the state of play with the Brexit negotiations at that time could muddy the waters.  

If a global downturn can be avoided, we believe rates should continue to edge up in both 2019 and 2020. So perhaps the upshot of Carney’s conundrum is that the city jargon should now change to “one more, and then some”? Not quite as catchy, I’ll admit, but in our view, it’s more likely to be closer to the reality.


LGIM contributors