United Kingdom: BoE in no hurry to lift off…

While, between 2004 and 2009, UK and euro GDP growth rates were similar, since 2011 growth has been much more dynamic in the UK (chart 1): over 2011-15, GDP grew at an annual rate of 2.1% in the UK against 0.5% in the euro area. Two factors explain the UK outperformance. First, the pound depreciated strongly in the aftermath of the Global Financial Crisis, while the euro appreciated sharply in effective terms. Second, their respective answer to the sovereign debt crisis was quite different: the UK tightened drastically during the first two years of David Cameron’s first mandate (at a time when the currency was depreciating) but then made a welcome pause in its fiscal consolidation as global activity started to slow down. In the Euro area, on the other hand, the strategy was to accelerate fiscal consolidation efforts in the same unfavourable external environment… whatever the consequences on growth (chart 2)!

Going forward, growth should weaken in the UK. In 2016, fiscal policy will indeed be tighter (the government has targeted a balanced fiscal position in 2019) (chart 3). Moreover, the uncertainty associated with the planned In-Out EU referendum could weigh on business investment and hiring decisions… while exports will suffer from poor competitiveness and an already-challenging international context. Furthermore, with weak consumer inflation expectations (chart 4), wage growth should remain subdued. All in all, in 2016, growth should be slightly under 2% and inflation well below 1%.

The Bank of England (BoE) is thus in no hurry to raise rates, all the more so since it could be politically touchy to move before the referendum (expected for June or September). Of course, keeping interest rates low for longer could fuel the housing market. But the Financial Policy Committee (the macro prudential arm of the BoE) has already taken measures in 2014 to calm the property market and the government has also decided that, from April 2016 on, anyone buying a second home or a buy-to-let property will pay a 3 per cent stamp duty surcharge. Moreover, additional initiatives are in the pipeline to give the BoE new instruments to prevent the formation of bubbles.