Is The Bank Of England's 'Super Thursday' Decision To Keep Interest Rates Unchanged Justified?

04/08/2017 14:04
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The Bank of England's Monetary Policy Committee has voted 6-2 in favour of keeping interest rates at the record low level of 0.25% in one of the key announcements on "Super Thursday". Also, economic growth forecast for 2017 was cut from 1.9% to 1.7% after slow increases in GDP in the first two quarters of 2017, where in total the economy grew by 0.5%.

It is expected that inflation, which is also referred to as CPIH in the UK, will increase by 0.1% in the third quarter to 2.7% and predicted to reach 3% in October 2017. According to the Office for National Statistics, CPIH has increased rapidly from 0.8% to 2.6% from June 2016 to June 2017 respectively. This implies Brexit has been a key reason as the fall in the value of sterling since the EU referendum has led to imports becoming more expensive, thus increasing prices for consumers. The Bank of England's target level for inflation is 2%. Hence, to reach its inflation target, the Bank uses Monetary Policy such as adjustment of interest rates in order to meet the target.

The case to increase interest rates is enticing because it could help to bring inflation down. Higher interest rates would encourage consumers to save more rather than spend. This is because, the interest paid on things like debts would increase and therefore it would make borrowing less appealing. Also, the encouragement to save instead of spend may, to some extent, slow down the economy. The slower growth in the economy would mean that in the medium term, inflation will depreciate. This would mean the gap between supply and demand would fall and consumers would have less to spend on goods/services, which makes them cheaper. Additionally, a rise in interest rates could increase the value of sterling, which would make imports lower priced and help to increase the supply of goods/services.

In contrast, lower interest rates can be justified as it can lead to higher spending due to the increase in the prices of assets. Therefore, this may lead to businesses becoming more productive and overall lead to higher GDP in the long term. It has been forecasted that the economy would grow by 1.6% in 2018 and this is a cut from the initial expectation of 1.7%, which highlights the "sluggish" growth that is expected. There is a lot of Brexit uncertainty as the Governor of the Bank of England, Mark Carney, said that the "UK's economic relationship with the EU weighs on the decisions of businesses and households." This could slow down growth because of the resultant impacts of decisions made by businesses on whether or not to stay in the UK. Moreover, with inflation expected to rise, "households" would have to make decisions on what they spend their disposable income as there is expected to be low wage growth. Due to Brexit having this negative impact on GDP, low interest rates and higher spending can lead to economic growth, which is needed for things like wage growth. Average wages are likely to stay the same at the 2% expected growth rate. Therefore, if prices are rising higher than wages, it could make the cost of living expensive and lead to household economic cutbacks on luxuries in order to save money.

The decision to increase rates may have been dismissed for this month, however, the Monetary Policy Committee believes that it is "possible" for an increase in interest rates later this year. This is the most viable option because the UK needs to offset the negative implications of Brexit and depreciation in sterling. However, higher interest rates would help to decrease inflation with consumers tending to save more and for demand to fall. An interest rate increase is essential, but the current rate of 0.25% is necessary for economic growth to occur due to Brexit uncertainties, so the Monetary Policy Committee's decision is justified- for now.