The Bank of England shocked financial markets today, saying that three of its policymakers had backed an interest rate hike, the closest it has come to raising rates since 2007, despite signs of a slowdown in Britain's economy.
Ian McCafferty and Michael Saunders joined previous rate rise advocate Kristin Forbes in voting to reverse the BoE's decision last August to cut rates to 0.25 percent, the BoE said today.
Bank of England Governor Mark Carney and four other members of the Monetary Policy Committee voted to leave rates unchanged.
Sterling jumped almost a cent against the US dollar and 10-year British government bond yields rose by 8 basis points on the news, which comes just a week after Prime Minister Theresa May unexpectedly failed to secure a parliamentary majority in a snap election.
Economists polled by Reuters had expected only Forbes – whose term on the MPC expires at the end of the month – to back higher rates, given the clear signs of a slowdown in economic growth in the first three months of 2017.
A fall in the pound after last week's election could push prices yet higher
"It's surprising that three members voted for a hike this time given that there are signs that the period of weaker economic growth is long lasting, and we've had more evidence this week of softer pay growth," said Investec economist Philip Shaw. "One would have to ask in this situation where the long-term inflation pressures would be coming from."
The US Federal Reserve raised American interest rates late on Wednesday and – notwithstanding some softening domestic data – signalled it is likely to raise rates once more this year.
The BoE said today that a jump in inflation last month to 2.9 per cent meant it was likely to exceed 3 per cent this autumn – higher than the BoE forecast just a few weeks ago and well above its 2 per cent inflation target.
Moreover, a fall in the pound after last week's election could push prices yet higher, the central bank said.
Britain's economy was the worst performer among the world's top seven advanced economies in the first quarter of this year as the effect of higher inflation caught up with consumers at a time of sluggish wage growth.
But the central bank said it was unclear how lasting this weakness would be, as consumer confidence remained solid. Moreover, indicators of investment and exports looked upbeat, and unemployment was its lowest in over 40 years, the BoE said.
"The continued growth of employment could suggest that spare capacity is being eroded, lessening the trade-off that the MPC is required to balance and, all else equal, reducing the MPC's tolerance of above-target inflation," the BoE said.
"Looking ahead, key considerations in judging the appropriate stance in monetary policy are the evolution of inflationary pressures, the persistence of weaker consumption and the degree to which it is offset by other components of demand."
The last time three MPC members voted for a rate rise was in 2011 – when there were nine members serving on the MPC – and the last time a single vote could have swung the decision on rates was in June 2007 when the committee split 5-4.
Due to election campaigning, Hammond has not yet announced a replacement for US academic Forbes – whose three-year term at the BoE expires at the end of the month – or for Charlotte Hogg, who has left the central bank after lawmakers criticised her failure to declare potential conflicts of interest.
Most economists polled by Reuters do not expect a rate rise until 2019. The outlook is clouded by uncertainty about whether May will be able to lead a stable government as she tries to negotiate an exit deal with the EU and navigate complex legislation through parliament.
May unexpectedly lost her parliamentary majority in an election last week – heavily damaging her standing with party colleagues – and is trying to get a commitment of support from Northern Ireland's main pro-British party.