Will Bank of England follow Fed rate hike in 2016?

With U.K. inflation hovering near zero and the slump in oil pressuring prices lower, an interest rate rise by the Bank of England looks increasingly less likely to come hot on the heels of the U.S. hike.

The annual rate of inflation rose to 0.1 percent in November, official statistics showed on Tuesday, suggesting the BoE may have a long wait before inflation starts to near the targeted 2 percent, incentivizing a rate hike.

"The inflation outlook has continued to quell any expectations for a near-term hike in rates from the Bank of England, with the latest push lower in energy prices set to push down on the recovery in headline inflation over coming months," Simon Smith, chief economist at FxPro, said in a research note after the data was out.

The Bank of England, London
Simon Dawson | Bloomberg | Getty Images
The Bank of England, London

The U.S. Bureau of Labor Statistics also posted its CPI for November on Tuesday. Reporting differences make a direct comparison with the U.K. difficult, but the U.S. index showed that inflation was unchanged in November on a seasonally adjusted basis and up 0.5 percent over the last 12 months before seasonal adjustment.

The BoE opted to hold the base rate at 0.5 percent this month, having made no hikes since 2006. The 0.5 percent rate has been maintained since a succession of interest rate cuts between December 2007 and March 2009, during and following the global financial crisis.

BoE Governor Mark Carney has hinted at an interest rate rise next year. According to the bank's inflation report from November, market pricing suggests rates will rise to 0.6 percent in the third quarter of 2016. Rates are then seen rising by 10 basis points each quarter in 2017 and 2018, to 1.3 percent.

The report forecast that if the BoE followed the path suggested by forward market interest rates, inflation would not reach the targeted 2 percent until 2017.

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"CPI inflation is likely to remain below 1 percent until the second half of 2016… reflecting the continuing drag from commodity and other imported goods prices. Thereafter, that drag dissipates and, conditioned on the market path, building domestic cost pressures are projected to take CPI inflation back to the 2 percent target in the second half of 2017 and above it in 2018," the report said.

However, a long-term appreciation in the U.S. dollar in response to the Fed hike could create inflationary pressure in the U.K., potentially bringing forward the timing of a BoE rise.

In general, higher domestic interest rates increase the value of a country's currency, as it become more attractive to foreign investors looking for returns. An appreciation in the dollar would cause sterling to fall by comparison, potentially generating inflation in the U.K. by making imports more expensive.

Ahead of the Fed move, the Institute of Directors, a British business lobbying group, said that a U.S. rate rise would alleviate some of the deflationary pressure in the U.K.

"This will give the Bank of England a little more flexibility once it decides to normalize interest rates on this side of the Atlantic," Michael Martins, economic analyst at the institute, said in a news release on Tuesday.

Andrew Sentance, a former member of the BoE's Monetary Policy Setting Committee (MPC), said that the U.K. would hike rates sooner than markets expected and that the U.K.'s economy had recovered to roughly the same extent as the U.S.

"There is no iron link between U.S. and U.K. interest rates, but if you look at the macroeconomic performance of the two economies, it's been remarkably similar. We have had roughly similar growth rates over the recovery; the recovery started at about the same time; it has been going on about the same time; unemployment has come down to just over 5 percent and inflation in both countries is expected to drift back up to target once the oil price factors drop out. So the same macroeconomic picture faces the MPC as faces the Fed," Sentance, who is now a senior economic adviser to PwC, told CNBC on Thursday.

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