It is not often that predictions of a central bank decision on interest rates change quite so dramatically within a few weeks of the meeting. As of mid-April, the financial markets were pricing in a probability of more than 90 per cent that the Bank of England’s Monetary Policy Committee would raise rates a quarter of a percentage point when it meets this Thursday.
That estimated likelihood has now collapsed to below 20 per cent. Investors are very probably right that the BoE will keep rates on hold. It would be reckless for the MPC to press ahead with a tightening, despite previously signalling it was likely. More generally it needs to give serious thought to the possibility that — as in previous years — the central bank has been too eager to find an excuse for bringing rates closer to historical levels.
The biggest piece of bad news that should keep rates unchanged was a strikingly weak performance for gross domestic product in the first quarter, rising by just 0.1 per cent. Some of that can be attributed to bad weather, but not all. The GDP figures were consistent with other evidence of a slowing economy. A regular survey of purchasing managers bounced back considerably less than expected in April following the poor weather in March.
All in all, the picture for the UK economy as on a steady, broad-based recovery now looks over-optimistic. Forecasters may have been too pessimistic about the immediate effects of the Brexit referendum in June 2016, but it now looks distinctly as if the shock was deferred rather than non-existent.
Last year the UK recorded the lowest annual expansion since 2013, and it has slid down the growth league table of advanced economies. The effect of the post-referendum dive in sterling, with an imported rise in prices driving down real incomes, is now passing through, but wage growth is still unimpressive given the low level of unemployment.
Moreover, it is very possible that coming Brexit-related shocks are on the downside, since companies are quite probably over-confident about its short-term effects on the business climate. Business organisations reacted with relief to the agreement between the UK and EU negotiators in March, which paved the way for continuity in trade arrangements in the transition period which starts next March. But with Theresa May facing fierce parliamentary opposition to her vision of Brexit, the potential for destabilising uncertainty remains considerable.
More than once, the bank has unnecessarily signalled a rate rise from which it then wisely drew back. It appears to have been operating in the same mode as the US Federal Reserve, confident of a sustained recovery and seeing a large part of its job as telegraphing and timing its tightening appropriately. In fact, given the performance of the economy and Brexit, it should be acting more like the European Central Bank, setting a high bar for signs of inflationary pressure before withdrawing stimulus.
As it happens, there has been a squall of weak data across several advanced economies over the past couple of months. It is incumbent on all central banks not to get ahead of themselves.
The race to succeed Mark Carney as governor of the BoE is just kicking off. One of the key determinants of who gets the job should be taking the right approach to monetary policy, and at present that means erring on the side of looseness and expressing a consistent determination to let the data rather than unrealistic expectations of growth guide movements in interest rates. Uncertain and potentially destabilising times lie ahead for the UK economy, and the MPC must be part of the solution rather than part of the problem.