MORGAN STANLEY: May's general election could push the Bank of England to raise rates

LONDON — The Bank of England could be pushed towards hiking interest rates sooner rather than later after parliament voted for a general election to be held in June, according to analysts at US banking giant Morgan Stanley.

Writing in a note circulated to clients on Wednesday, Morgan Stanley economists Melanie Baker and Jacob Nell, as well as strategist Sheena Shah argue that the shock election could lead to a major shift in the directions of both fiscal and monetary policy in the coming months.

The trio expects the Conservative party to win the election and increase their parliamentary majority, after which point the Chancellor of the Exchequer — be it incumbent Philip Hammond, or a new appointment should Theresa May announce a reshuffle — will seek to loosen fiscal policy in order to fund public spending and infrastructure projects.

As Nell, Baker, and Shah put it:

“In the Conservative manifesto, we expect fewer specific commitments and more flexibility to react to the uncertainties created by Brexit. We also expect a greater focus on public spending, such as housing, health and education, and greater willingness to intervene in the economy. That, we think, points to a risk of looser fiscal policy.”

This, in turn, could lead the Bank of England to start a tightening cycle sooner than may have been expected. Here is the rationale from Morgan Stanley:

“The combination of greater political stability, from a larger Parliamentary majority, and easier fiscal policy, should be positive for growth. With an MPC that is starting to lean towards a hike as a result of stronger growth and inflation above target, this points to an upside risk to our current ‘on hold’ rate call.”

The bank currently maintains a neutral stance on rates — meaning it has no bias toward cutting or hiking — having done so since late last year, around three months after cutting interest rates from 0.5% to 0.25%, and boosted its QE programme in August 2016, as a means to protect the UK from the coming economic shock of Brexit.

However, in recent statements, the BoE has made hints that a rate hike back to 0.5% — where the base rate stood for close to seven years post-financial crisis — could be on the horizon.

“There are limits to the extent that above-target inflation can be tolerated,” the bank said after the last meeting of the Monetary Policy Committee in March.

“Some members noted that it would take relatively little further upside news on the prospects for activity or inflation for them to consider that a more immediate reduction in policy support might be warranted.”

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