BoE holds rate, hints at future increase

With the global economy growing strongly, the Bank of England is growing more confident about Britain’s near-term prospects. It indicated it could raise interest rates in coming months—even in the face of uncertainties over the country’s exit from the European Union.

The BoE kept its main interest rate on hold at 0.5% on Thursday, as expected, but the bank also indicated it could make three more quarter-point hikes over the next three years. The next hike could come as soon as May, when the bank will publish its next set of quarterly economic projections.

The pound rose sharply on the news, gaining 0.8% against the dollar to $1.3986 as investors factored in higher rates.

Read: Is the eurozone out of the debt crisis?

The BoE had in November lifted its main rate by a quarter point, its first hike in a decade, to keep a lid on inflation. Prices had been rising sharply due to the pound’s sharp fall after the June 2016 vote for Brexit. The pound’s drop simultaneously pushed up import costs, notably of food and energy, and weighed on economic growth by reducing living standards as price rises started to outpace wage growth.

Though the outlook for the British economy is conditional on the outcome of the Brexit discussions, particularly what the future trade relations will be, the central bank’s rate-setting Monetary Policy Committee said that “monetary policy would need to be tightened somewhat earlier and by a somewhat greater extent” than it anticipated in November.

That view is based on the assumption that the British economy grows in line with the bank’s forecasts, published Thursday in its so-called Inflation Report. It includes an assumption that Britain will be able to get “a smooth adjustment” to a new trading relationship with the EU.

Brexit tensions

The minority Conservative government appears deeply split on Brexit: while some lawmakers in Prime Minister Theresa May’s party want close ties with the remaining 27 EU nations and a period of transition, others want a more fundamental break that would see Britain diverge more profoundly on regulatory and trade matters.

Meanwhile, the views of the opposition Labour Party, which may be a determining factor should there be a parliamentary vote on any final Brexit deal, are also considered opaque.

Britain is due to leave the EU in March 2019. Before then, May hopes to agree on a transition deal with the EU that would see Britain remain in the tariff-free European single market and customs union for a period after Brexit day.

That would give firms and households time to adjust to any new relationship with the EU—Brussels has said any transition period should finish by the end of 2020 and can only take place if the outlines of a future relationship is agreed upon.

BoE Governor Mark Carney has argued strongly that an agreement on the terms of a transition has to be secured by the end of the first quarter this year so businesses can plan ahead. Many firms have held back investment amid the uncertainty and some, particularly in the financial sector, have warned they could relocate some activities into the EU if there is no further clarity soon.

For now, the Bank of England has to deal with the economic backdrop as it is and that—despite this week’s volatility in stock markets—is more benign than it anticipated just three months ago and certainly more so than after the Brexit vote in June 2016.

Higher growth projected

The central bank has raised its economic growth projection for this year to 1.8% from 1.7% last time, largely because it has raised its global growth forecast to 4% from 3.75%, an uptick that is helping exports. The forecast is based on interest rates rising as markets anticipate.

Though the anticipated growth level is modest in historic terms, it is higher than the 1.5% level the Bank of England currently considers to be the British economy’s trend rate. That is expected to push up inflation, according to the Bank.

As a result, the central bank thinks inflation will remain higher than its 2% target rate over the coming three years, even though the price-boosting impact from the pound’s depreciation fades. From 3% currently, the bank is projecting the annual rate of consumer price inflation to fall to 2.3% this time next year and 2.2% the year after.

Inflation rose last November to 3.1%, more than a percentage point above target, requiring Carney to write to Treasury chief Philip Hammond to explain what the bank was planning to do about reining in price increases. Though a bit out of date, their exchange of letters was also published Thursday.

Carney told Hammond that the MPC is “conducting monetary policy to return inflation sustainably to target at an appropriate horizon while supporting jobs and activity in exceptional circumstances.”

There was a caveat.

“Developments regarding the United Kingdom’s withdrawal from the European Union remain the most significant influence, and source of uncertainty about, the economic outlook,” he said.