Sterling Strength Gives Bank of England Rate-Setters a Headache

As the Bank of England moves closer to raising interest rates for the first time since 2007, the strength of sterling is causing disagreement among its policymakers over when to pull the trigger.

The BoE is due to make a slew of announcements on Thursday, among them its forecasts for inflation, which will give investors a better sense of how soon rates are likely to rise.

The pound hit its highest level in over seven years against the currencies of Britain’s main trading partners last month, bolstered by expectations of higher interest rates as the country’s economy recovers. This week, the bank will need to take a stand on how long the effect of strong sterling will last.

The BoE’s rate-setters must decide whether the effect of cheaper imports and reduced demand for British products abroad will last long enough to justify a cut to its forecast for inflation in two years’ time. Private-sector economists would usually interpret this as a sign that the bank is unlikely to raise interest rates in the coming months.

However, some policymakers might still want to tighten policy if other factors – such as the speed at which wages are rising, relative to a small recovery in productivity – point to underlying price pressures in the slightly longer term.

“At that point, the decision on what to do with interest rates becomes more complicated,” said Robert Wood, a former BoE forecaster who is an economist at Bank of America Merrill Lynch.

While the BoE typically ignores factors with a brief impact on inflation such as swings in oil and food prices, big currency moves are on the borderline between a short-term and a long-term factor.

British inflation is currently forecast to bounce back from zero to its target of 2 percent within two years. But if Thursday’s forecasts show this may take rather longer, the chances of a rate rise before early next year will fade.

Reuters

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