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BOE Rate Hike in May Looks Increasingly Likely

  • Officials are worried about domestically generated inflation
  • U.K. central bank publishes next policy decision on Thursday

Bank of England policy makers look increasingly likely to raise interest rates at their May meeting after data suggested faster domestically generated inflation is on the way.

Wages are rising at their fastest pace since the end of 2016, the Office for National Statistics said Wednesday, a sign that the tightness in the labor market is stoking price gains just as the currency-driven jump in headline inflation starts to drop off. That could spur policy makers to act as households get some long-awaited relief from a yearlong squeeze on their incomes.

Prime Minister Theresa May’s government lifted the cap on pay for more than a million National Health Service workers on Thursday. They will get a 6.5 percent pay rise over the next three years -- spelling an end of the longstanding limit on public-sector raises -- while a 4.4 percent increase in the minimum wage is also due to come into effect in April.

BOE officials, who raised rates for the first time in more than a decade in November, are preparing to unveil their latest policy decision in London on Thursday. Markets had started to price in further tightening at the next meeting in May even before the positive upturn in wage growth, while a second hike this year is also seen as probable.

Hiking Cycle

Investors see May as a near lock-in for BOE, second hike this year looks likely

Source: Bloomberg

“In BOE speak, higher wages point to upside risks to domestically generated inflation and improving jobs numbers point to further erosion of slack,” said Scotiabank economist Alan Clarke. “In other words, this supports the case for a May rate hike.”

Investors now assign an 88 percent chance of a hike in May, while a follow-up increase in November is about 63 percent priced in. At the end of 2017, investors were pricing in slightly less than a full quarter-point move for the whole of this year.

What Our Economists Say:

“Evidence of a booming jobs market and continued upward pressure on pay growth mean it now looks likely the Bank of England will lift interest rates in May. We previously anticipated an August hike. With the unemployment rate set to tumble below its sustainable level later this year, another hike is likely in November.”

--Dan Hanson and Jamie Murray, Bloomberg Economics

The U.S. Federal Reserve is moving ahead resolutely with policy tightening, and is expected to raise interest rates on Wednesday. Some observers predict its new chairman Jerome Powell will unveil fresh forecasts and language that may hint at four rate hikes this year, rather than the three increases anticipated in December.

In the U.K., basic wage growth accelerated to 2.6 percent in the three months through January, as the employment rate returned to a record high and the jobless rate fell to 4.3 percent to match the lowest since 1975. Meanwhile consumer prices rose 2.7 percent in February from a year earlier, down from 3 percent in January but still well above the 2 percent target.

Economic optimism has also gained a boost after Brexit negotiators reached a breakthrough this week on securing a transition deal once the U.K. quits the European Union next year. The BOE last month identified the split as the most significant source of uncertainty over the outlook, with Governor Mark Carney previously urging the government to agree a hand-over deal the sooner the better.

“If there was any doubt that the U.K. Monetary Policy Committee is likely to sound hawkish when it meets tomorrow, this report dispels it,” said Adam Chester, head economist at Lloyds Bank Commercial Banking. “A May rate rise looks highly likely.”

— With assistance by David Goodman

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