The Bank of England may find itself behind the curve on inflation, says Mark Nash, head of fixed income at Old Mutual Global Investors, after the first UK interest-rate increase in a decade.
 
'The pace of growth in the UK economy has been supported for years by the increase in labour supply into the country. With fewer people now coming to the UK from the EU, and unemployment rates on the floor, it’s left to productivity to take up the slack for the UK to grow.
 
With investment in the UK rising – in line with the rest of the global economy – a productivity spurt is still possible. However, investment growth is unquestionably less high than it would otherwise have been due to Brexit-related uncertainty, meaning the level at which the UK economy can function without generating inflation is also going to be low.
 
Put simply: demand doesn’t need to be that strong to pressure prices higher – the hurdle for inflation to quicken has fallen.
 
This is a stark warning for investors that inflation risk is real and more likely going forward, especially in the UK due to its unique circumstances in a global economy, which to quote Bank of England (BoE) Governor Mark Carney, is firing on “11 out of 12 cylinders.”
 
Market participants do not seem alarmed – conditioned for years that demand is the problem, not inflationary pressures. If the message wasn’t clear enough, the BoE is still sticking to its forecasts of higher wages, which run along the same line of thinking that UK economic capacity is dwindling.
 
However, this is perhaps not surprising as, although the BoE is clear with this warning, its outlook for interest-rate increases remains very timid, suggesting only two more hikes are likely to be needed over the next few years. Even though remarkably policymakers still see inflation above their target over their two-year forecast horizon.
 
The macroeconomic debate in the UK has clearly changed, as the Monetary Policy Committee highlighted today. Yetby failing to back this view with decisive action, the central bank risks making a policy mistake – not by conducting a 25 basis point rate increase, but by being too cautious on the outlook for rates over the medium term.'