Monetary Policy

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Monetary Policy


In a week littered with economic data, the Bank of England’s (BoE) Monetary Policy Committee (MPC) announced interest rates would remain unchanged.

Market participants continue to speculate whether the BoE will look to raise interest rates in May. At the time of writing there is a 75% probability assigned by analysts to a 0.25% hike taking place.


Chart 1: Probability of a 0.25% interest hike in May 2018

Last month, the MPC said it was likely to raise interest rates earlier and faster than previously expected. This is regarded as a cautionary response to a stronger global economy. Although we point out later that inflation is expected to fall in the UK, the BoE must take into consideration the wider global growth back-drop and the impact that stronger economic activity may have on future prices.

With UK inflation currently heading backdown towards the BoE’s 2% target level, the impact from stronger global growth does not appear to offer an imminent threat.



The Federal Open Market Committee (FOMC) meeting, with new Chairman Jerome Powell at the helm, was keenly anticipated by central bank watchers. The 0.25% increase in interest rates, the first raise this year, was widely expected. The main feature was the provision of further guidance on future rate hikes.

Powell’s predecessor, Janet Yellen, pursued a strategy of increasing interest rates gradually and there were some worries that the new incumbent would opt for faster rate hikes.

The 0.25% increase takes the current level (range) to 1.5% – 1.75%. However, the Committee forecast a steeper path for hikes in 2019 and 2020, saying “the economic outlook has strengthened in recent months”.

The changes to US interest rates we are seeing currently signifies that the economy is robust and in a position of strength. Judging whether the economy can withstand higher rates without derailing growth does, however, require some very fine judgements. The US central bank is keen to ensure they are not seen as being weak on inflation but they also have a statutory mandate to foster maximum employment.

Powell highlighted that “the jobs market remains strong, the economy continues to expand and inflation appears to be moving towards the FOMC’s 2% objective”.

The generally positive backdrop is made clear in the table below.

% refers to annualised rate. Source: Bloomberg, March 2018

The Fed also announced their new economic projections. Gross domestic product is forecast to grow by 2.7% this year (from 2.5%) and 2.4% (2.1%) next. Unemployment is expected to drop to 3.8% this year and to 3.6% next year from the current level of 4.1%.

The Fed ‘dot plot’ chart below is fascinating. It illustrates where each Fed governor expects the Fed Funds rate to be at certain points in the future.

Federal funds target rate (%)

Source: Financial Times, March 2018

In terms of rate rises, this year the consensus is for three increases, but the number of officials expecting 4 rate hikes has doubled from 3 to 6. If those 6 officials are proved right, and the Fed also raises rates twice in 2019 and twice again in 2020, interest rates will move up to a range of 3.25%-3.5% in 2020. At this level it would mark the first time in more than a decade that interest rate policy is deliberately restrictive.

Global Markets