The Role Of Import, Export & Exchange Rates On BoE’s Interest Rate Decision, & What It Means For The Rest Of 2018

Bank of England Governor Mark Carney announced today that the BoE’s Monetary Policy Committee have voted unanimously to hold interest rates at 0.5%, before warning; don’t be surprised if we raise them twice before the year is out.

Carney and the BoE are battling rising inflation, which has fallen 0.1%, to 3% from November to December. It’s not enough, they say, and have now set a target of bringing the level down below 2% within 2 years, as opposed to the 3 year timeframe that had previously been indicated.

In its inflation report, The BoE says that the blame for rising inflation levels is “almost entirely due to the effects of higher import prices following sterling’s past depreciation,” illustrating the significance of Sterling’s fall against the dollar, of 10%, and to a 31 year low, post Brexit. The recent rise in oil prices has also played a role in inflation, they added.

Investors had factored in the possibility of only 2 or possibly 3 quarter-point rises over the next 3 years, which explains the recent turbulence in the stock market, as the City prepares for an entire percentage point rise to occur within the next two years.

This is in large part a response to economic policy in the US, which is also expected to hike interest rates more than expected over the next two years. In general, higher interest rates are good news for savers, and bad news for borrowers.

The decision made by the BoE also in part reflects an overall positive upturn in global growth as the world moves further on from the global financial crisis of 2008; but what does this mean for the UK’s global trading prospects?

The BoE says that “greater export demand, combined with the rise in profit margins on exports in sterling terms should encourage new and existing exporters to expand their production.” Greater export demand is an almost direct result of Sterling’s fall; it is still trading around 15% below its pre-referendum level.

Higher import prices should also encourage Britain to buy more domestic products, the BoE speculates, although it is worth noting that a falling dollar also makes it cheaper to import from the US – a key part of Donald Trump’s plans to return America to its past position as one of the world’s biggest manufacturing countries and exporters of goods.

And then, of course, there is Brexit; the BoE explains the situation like this: “Net trade will also depend, however, on how companies here and abroad begin to adjust trading relationships in light of the United Kingdom’s prospective withdrawal from the European Union.”

In general, the BoE appears to be optimistic. Their calculations show that export growth has increased 8.4% in the year to 2017 Q3, and that “between 2015 Q4 and 2017 Q3 export prices fell 7% in foreign currency terms, suggesting some increase in competitiveness.” In Sterling terms, export prices have actually risen 12%, whilst in foreign currency terms, they have fallen 7%, which is good news for UK exporters’ profit margins.

All that said, import growth is on the rise, although it is expected to be tempered somewhat in the coming year, and the BoE believes that “the projected strength of exports in Q4, relative to imports means that net trade probably contributed significantly to GDP growth in Q4.”

Finally, the current account deficit, defined as “the current account the balance of nominal trade flows and other payments between the United Kingdom and rest of the world”; narrowed to 4.5% of GDP, a reflection on the narrowing of primary income. Wage growth is expected in 2018, after a stagnant 2017.

It is never easy to apply economics to making predictions about what might happen in the “real world”, but it does appear that, by attempting to “fix the roof while the sun’s shining”, hike rates, and drive down inflation, the BoE is anticipating a relatively smooth divorce form the EU, with trading prospects post Brexit expected to be broadly positive.

Sterling can surely move only one way against the euro; up; whilst parity with the dollar is probably the most likely outcome at this stage. It seems incredible today to think back to a time when interest rates were positively buoyant at more than 14% under Margaret Thatcher, before the UK got itself into another sticky situation with the EU; its short lived attempt to join the single market; which caused Black Monday to happen, and saw the value of the pound collapse completely.

Nobody was expecting that, so it may be best to prepare for further turbulence, even whilst prospects for a more stable, “normal” economy, remain high.

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