The Bank of England is seriously considering raising rates for the first time in 10 years against a backdrop of lacklustre economic growth, as a Guardian analysis shows the Brexit vote sapping business confidence and hitting household income.
As Mark Carney, the Bank’s governor, prepares to hike the cost of borrowing for the first time since 2007 from as soon as next week, key barometers of economic strength are faltering. Nevertheless, City analysts expect Carney and his panel of rate setters on the monetary policy committee to vote for a rate hike on 2 November.
Threadneedle Street is thought to have backed itself into a corner – with financial markets reckoning there is an 80% chance of a hike – after the MPC said at its last meeting in September it could move to increase rates within the “coming months”. Stepping back from the brink may now cause the pound to fall and would undermine the central bank’s credibility, having been called an “unreliable boyfriend” once before for failing to act on its hints.
As the Bank considers reversing last year’s emergency rate cut to 0.25% from 0.5% to avert a Brexit-induced recession, the Guardian’s tracker of economic news is now painting a picture of tougher times for consumers. Against this backdrop, Carney has been warned of the risks for raising interest rates.
Writing in the Guardian, David Blanchflower, a former member of the Bank’s rate-setting monetary policy committee, said: “This is no time for a rate rise as the economy slows.”
To gauge the impact of the Brexit vote on a monthly basis, the Guardian has chosen eight economic indicators, along with the value of the pound and the performance of the FTSE 100. Economists make forecasts for seven of those barometers ahead of their release, and in four cases the outcome was worse than expected.
Households are reining in spending amid a protracted squeeze on living standards from rising inflation, coming as a result of higher import costs due to the drop in the pound since the referendum. High street sales slumped last month, pushing the UK retail sector to its lowest growth rate in four years for the three months to the end of September.
Inflation reached a five-and-a-half-year high in September, edging up to 3% from 2.9% in August, with food prices and transport costs driving the increase. The MPC has said it expects inflation to peak above 3% in October, which would force Carney to write a letter to the chancellor to explain his failure to target inflation at 2%.
Under questioning from MPs on the Treasury select committee, the governor said it was “more likely than not” he would be writing to Philip Hammond and that the effect of the weak pound – still more than 10% down on the dollar since the referendum – would still be felt three years after the vote.
Lingering high inflation could provide the ammunition for the Bank to target a rate hike, as raising the cost of borrowing pushes down demand for products and therefore lowering prices. Threadneedle Street may also want to use higher rates to curb the rapid growth of personal loans, credit cards and car finance.
Another former MPC member, Andrew Sentance, backed a rate rise for this reason despite the subdued growth signals. Writing in the Guardian, he said: “A rate rise – and the promise of more to come – should help sterling and take some of the inflationary pressure off consumers.
“A gradual policy of edging interest rates up would also head off an unwanted surge in borrowing which is at risk of developing on the back of prolonged low interest rates. The MPC has already left it too long to start the process of gradually raising interest rates and should not put it off any longer.”
The latest dashboard shows some bright spots, with unemployment remaining at its lowest level since the mid-1970s and the FTSE 100 hitting a record high. Britain also recorded the smallest gap between public spending and tax receipts for the month of September in the past 10 years, helping the chancellor as he prepares for his budget next month.
However, there are warnings that a rate hike might be premature, as the higher cost of borrowing could further dent the spending power of consumers and businesses. “Magnified by Brexit risks, we see danger in prematurity,” said John Wraith of the Swiss bank UBS.
The lowest level of unemployment since 1975 is still failing to boost the bargaining power of workers in the UK, as figures for the last month showed negative real wage growth. Threadneedle Street has been looking for signs of rising earnings because it would show households might be able to withstand higher borrowing costs.
Company bosses blamed Brexit uncertainty and the higher cost of goods used due to inflation – making it difficult for them to offer better pay packages. Firms have been avoiding investment due to fears over the lack of progress in talks between ministers and Brussels.
Businesses could be further discouraged after Theresa May said there would be no transitional deal to leave the EU until the UK’s future trading relationship is settled. Firms had been pushing David Davis, the Brexit secretary, to quickly sign such an arrangement or risk losing jobs and investment.
The Guardian’s Brexit dashboard shows the key barometers of sentiment among companies about business activity were negative in September, barring a modest rise in activity in the services sector, the UK’s biggest industry.
Britain’s construction industry showed signs of contracting for the first time since the immediate aftermath of the referendum, as work started before the vote comes to an end and isn’t replaced by enough new commissions amid political uncertainty. Manufacturers also reported higher prices for goods used in the production process, eroding the benefit from the weakness in the pound when selling abroad.
Some companies have warned of skills shortages exacerbating their costs, amid early signs that some EU migrants are starting to leave the UK. Less spending by firms point to a potential growth slowdown, according to Sentance, who said it could push the UK from the top two places in the G7 growth league between 2013 and 2016 – to the bottom for this year.
Britain’s sluggish growth – which is expected to be confirmed in official GDP figures on Wednesday – also comes as other economies roar ahead. “The weakness of domestic investment and consumer spending is preventing the UK benefiting from a general upswing in the global economy and an improvement in growth in the rest of the EU,” Sentance said.
The storm clouds for the economy are also gathering as Philip Hammond prepares to deliver his budget next month. Alongside the weak economic data, the chancellor was also dealt a blow from the government’s independent economic forecaster, which said it would need to “significantly” lower its expectations for the productivity of British workers.
The Office for Budget Responsibility said the average rate of productivity growth of 0.2% over the past five years was a better guide for 2017 than its forecast of 1.6% in March.
Treasury officials believe the downgrade will wipe out about two-thirds of the government’s £26bn budget surplus from 2017 to 2021, which had been seen as a stockpile for a potential slowdown and disorderly EU exit. Businesses are calling on the chancellor to spur the economy through spending on infrastructure, offsetting the uncertainty of leaving the EU by boosting activity at home.
Blanchflower said austerity was a major factor behind the weaker than hoped for growth in productivity. “Output per man hour today is essentially unchanged ever since the austerity was imposed by the coalition too effect,” he said.
“As a consequence, the public finances are in much worse shape than the chancellor has claimed, given there is likely much less growth,” he added.