Bank of England is expected to keep monetary policy on hold in September and will likely remain in wait-and-see mode at least until the next round of economic forecasts due in November.
The latest Purchasing Managers' Index (PMI) surveys from Markit Economics showed the economy remains less balanced than desired, with the manufacturing sector slowing from early 2014 highs, while construction and services continued to roll on at steady pace in the third quarter.
Despite a surge in the services and construction sectors, which both account for a significant 84% of the total gross domestic product (GDP), the majority of economists suggest no immediate change to the Bank of England's (BoE) policy stance in September. The base rate looks likely to stay at the record low of 0.5% and the volume of asset purchases at £375 billion after Thursday's announcement.
But the signs of the economy keeping its momentum in the second half of this year should continue to keep the pressure on the nine-member Monetary Policy Committee (MPC), which was split two against seven for an immediate rake hike in August - the first split on rates since July 2011.
Two external MPC members, Ian McCafferty and Martin Weale, voted for an immediate 25 basis point (bp) rate hike in August. The question now remains whether the pool of dissenters from Carney's dovish stance remains or has widen even further. The fact that Martin Weale voted for a rate hike in August may have not come as a total surprise given the fact that he had already voted seven times for a 25-bp hike between January and July 2011, when the economy appeared much less vital than at present.
With the rift in the MPC probably continuing through the upcoming months, the whole of the committee will be closely watching other significant macro data to steer the policy accordingly. Labor market data, wage growth in particular and its possible impact on the medium-term inflation outlook, will be among those fundamental variables.
So far, significantly low wages prompted policymakers to downgrade their estimate for the 2014 annual earnings growth by as much as half, from 2.5% down to 1.25%, as the latest official data showed average weekly earnings had declined 0.2%, while wages excluding bonuses had grown only 0.6%, which was the weakest growth recorded and far below a 4.1% earnings growth in January 2008 during the pre-crisis peak quarter.
Therefore, the upcoming labor market data, due on September 17, will be of significant importance for the next MPC monetary policy decision in October. The data due in November and December should then confirm if the trend is likely to remain sustainable.
Doves firm up position
Despite the rift among the members, the August MPC minutes revealed an unusually strong dovish position for the majority of policymakers, including Governor Mark Carney, saying headwinds faced by the domestic economy still posed significant concerns even under the current ultra-loose monetary policy. The latest PMI surveys also highlighted the Russia-Ukrainian crisis as a potential drag on output.
"It was possible that, given the strength of the headwinds faced by the economy, even the current extraordinarily low level of Bank Rate was not providing a great deal of stimulus to activity," the August MPC minutes said, adding that "a premature tightening in monetary policy might leave the economy vulnerable to shocks, with the effectiveness of any further necessary stimulus being limited by the effective lower bound on Bank Rate."
However, paraphrasing several top BoE officials including Mark Carney, the upcoming decisions on monetary policy will strongly depend on the strength of the incoming macro data. Also, some reports and speculations have been circulating in the City of London hinting at some unwritten pact between the BoE and the Treasury to keep rates low until the next general elections. Both the BoE and the Treasury have dismissed those reports as utterly false.
Pressure from businesses
More pressure has been piling up on policymakers from UK businesses across the country, with the British Chambers of Commerce (BCC) being very vocal about the need to keep interest rates low for longer to allow businesses to invest more.
"While the large majority of committee members still believe in the existing policy of keeping interest rates low, it is disappointing that two members voted for an immediate increase at the last MPC meeting. With inflation well below target and wage growth stagnating, any increase in interest rates at the moment would be premature," David Kern, chief economist at the BCC said after the August MPC minutes release on August 20.
"The economic recovery is still not secure and growth amongst UK businesses must be fostered in a low interest rate environment. The risks from raising rates too early are much greater than the risks of waiting just a little longer," he added.
Whether it is politics or business, it appears Carney's BoE is determined to allow more time before tightening policy, given concerns about significantly indebted households, a still fragile and poorly balanced economic growth, and headwinds faced by the economy from both the Russia-Ukraine and the Middle East crises.
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