Stronger UK growth shows need for higher rate, Carney says

By BLOOMBERG

LONDON • The UK economy is showing signs of rebounding from a sluggish first quarter (1Q) of the year, supporting the view that it will require higher interest rates, according to Bank of England (BoE) Governor Mark Carney.

“Domestically, the incoming data have given me greater confidence that the softness of UK activity in 1Q was largely due to the weather, not the economic climate,” Carney said, speaking in Newcastle, northeast England, yesterday.

His upbeat remarks on growth leave the door open to a BoE interest-rate increase as early as the next meeting on Aug 2, when officials also update their forecasts. Investors currently see about an 80% chance of a quarter-point move next month.

Carney didn’t offer specifics on the timing of the next hike.

If the economy continues to perform as policymakers expect, “an ongoing tightening of monetary policy over the next few years would be appropriate to return inflation sustainably to its target”, he said.

When the BoE made its last policy decision, statistics showed the economy nearly stopped growing in the first three months of the year. That figure has since been revised up to 0.2% by the Office for National Statistics, and incoming data for the current quarter have been stronger.

“Indicators of household spending and sentiment have bounced back strongly from what increasingly appears to have been erratic weakness” in 1Q, he said.

Yesterday, Carney “sounded more confident that the economy was likely to rebound in 2Q. We share his optimism and expect the central bank to hike interest rates next month,” said Dan Hanson of Bloomberg Economics.

Last month, three officials dissented in favour of hiking rates immediate at their meeting, saying the economy is running out of slack.

While global growth has recently moderated slightly, the underlying picture is still strong and supportive for the UK, Carney said. Still, he warned that the escalating tariffs on trade will result in slower economic growth and faster inflation, making monetary policy more difficult.

Central bankers “need to take into account the potential for reduced trade to result in more fundamental changes to the relationship between domestic slack and inflation, which could steepen and shift up as trade falls back,” he said.

The US is set to begin imposing additional steep tariffs on Chinese imports as of today, and Beijing is poised to respond in kind. With further tit-for-tat levies already threatened, this week could mark the start of a new and dangerous phase of a trade war.

Protectionism affects the real economy through direct channels like reduced trade flows, disrupted supply chains and higher import costs, Carney said. There are also indirect effects, via business and consumer confidence and financial conditions.

The tariffs announced so far will broadly double the average bilateral tariff rates and could raise average US tariffs to levels not seen in over 50 years, he said. BoE analysis shows that a 10 percentage point increase in tariffs between the US and all of its trading partners could knock 2.5% off of US output, and 1% off global growth.

Furthermore, the impact of Brexit on the UK so far shows that the impact of a trade war will be greater the more business confidence is impacted, the more financial conditions tighten and the more permanent the loss of openness is expected to be, Carney said.