Andrew Sentance's vote for a rise in interest rates took financial markets by surprise. Here are reactions from economists.
Malcolm Barr, economist at JP Morgan
Though a recent newspaper article by Sentance had made it clear he was moving toward voting for monetary policy to begin to tighten, we had not thought he was ready to actually vote for such action yet.
The key question this poses is the extent to which other members of the committee may be sympathetic to Sentance's view, such that a majority for higher rates may form. Based on both the June minutes and the drift of recent commentary from other MPC members, we think Sentance's position is rather isolated. Certainly the minutes suggest there is some unease at recent inflation performance … Recent voting behaviour suggests Spencer Dale is the MPC member most likely to be close to Sentance's view, and commentary from him in the coming weeks should be watched closely. But in the meantime, we would not over interpret the significance of Sentance's vote as a signal as what is to come next from the MPC.
Philip Shaw, economist at Investec
The next quarterly inflation report, due on 11 August, will be a critical event for interest rates as it will effectively outline the MPC's 'reaction function' to yesterday's budget. Although members did not appear to know the contents of the chancellor's red briefcase at this month's meeting, they seemed to be more concerned over a VAT hike dislodging inflation expectations, than a squeeze on fiscal policy hitting demand. Our best guess is still that the MPC will begin to raise rates in Q4 this year, partly as the recovery gains traction and also as the committee fears losing some of its anti-inflation credibility as headline rates of inflation remain above the 2% target. In that respect the 2.5% increase in VAT to 20%, taking place in January, will probably keep inflation above its target for a further 12 months. We also note that a big fiscal squeeze in the early to mid-1990s was not followed by a noticeable slowdown in the economy. Indeed two tight budgets in 1993 were followed by GDP growth in excess of 4% the following year. While the economy may not shrug off the current round of fiscal tightening quite so easily, the general point will not be lost on the MPC.
Howard Archer, economist at IHS Global Insight
While there is clearly the possibility of a token interest rate hike before the end of the year if inflation provides further upside surprises over the coming months, we still believe it more likely than not that the Bank of England will keep interest rates down at 0.50% through 2010 given relatively muted recovery, and serious threats to growth coming not only from the fiscal squeeze that will increasingly start to bite but also from the eurozone crisis. The budget may well lead to increasing consumer and business caution even before some of the measures are imposed or start to bite.
Vicky Redwood, senior UK economist, Captial Economics
For now, most members appear to be holding their nerve. And if they – and us – are right in expecting inflation to fall sharply over the next few months, interest rates are likely to be kept at their record low for a long time yet.
In fact, given the fiscal squeeze now underway, the MPC may yet have to give further support to the economy. After all, in his Mansion House speech last week, Mervyn King said that a reduction in the budget deficit should not be postponed and that "if prospects for growth were to weaken, the outlook for inflation would probably be lower and monetary policy could then respond. We still expect another £50bn or so of quantitative easing to be announced later this year or early in 2011.
James Knightley, economist, ING Financial Markets
There is a major surprise within the Bank of England minutes in that one member, Andrew Sentence, actually voted for an interest rate rise … However, the rest of the committee thought that "changes to the balance of risks were insufficient to warrant a change in the stance of monetary policy". Essentially, they wanted to see the scale of fiscal austerity. Given that it is severe with a fiscal drag of 7.9% of GDP over five years we continue to believe that growth will disappoint and inflation will fall significantly. While the VAT hike will boost headline inflation in 2011, the Bank is looking at inflation on a two year horizon, and the VAT hike will drop out of the annual comparison in 2012, depressing CPI. Moreover, with significant public sector job losses likely there is the risk that a lack of vigour in the private sector means unemployment will continue to rise. This will limit the chance of second round price effects through higher wage demands.
So with growth likely to be sub trend for much of this parliament and inflation falling sharply below target at the end of the Bank's forecast period we continue to look for rates to remain ultra low for the coming year and ongoing weakness in sterling.