King Faces Ticking Clock on Interest Rates as Inflation Soars

The clock is ticking for Bank of England Governor Mervyn King as the weakness in the economy forces policy makers to endure soaring inflation and refrain from raising interest rates.

While all 62 economists in a Bloomberg News survey say the bank will leave its benchmark interest rate on hold at a record low 0.5 percent today, investors have added to bets on an increase in the first half of the year. Former rate setter DeAnne Julius said yesterday the bank needs to tighten policy “sooner rather than later” or risk losing credibility.

“It’s now come to this position: we have to have an improvement in inflation or they have to raise rates,” said Steven Bell, chief economist at London-based hedge fund GLC Ltd. and a former U.K. Treasury official. “The clock is ticking. May is now everyone’s favorite date.”

The Monetary Policy Committee’s deliberations today will be based on new forecasts, which King will present to the public on Feb. 16. Inflation accelerated to 3.7 percent in December, almost double the bank’s target, and minutes of the January meeting showed “most” of the panel noted that medium-term risks had “probably shifted upwards.”

The pound fell 0.3 percent against the dollar to $1.6045 at 9:35 a.m. in London.

The central bank is due to announce its decision at noon in London. It will also hold its bond-purchase program at 200 billion pounds ($322 billion) today, a separate survey shows.

Divided Committee

While former policy maker Tim Besley said in a Feb. 4 interview that the central bank’s new projections are likely to show inflation easing to the 2 percent target, current officials are divided on the outlook for consumer prices.

Six of the nine members voted to leave policy unchanged last month, and Martin Weale and Andrew Sentance voted to raise rates. Adam Posen maintained his call for additional stimulus after the economy shrank in the fourth quarter.

U.K. manufacturing unexpectedly declined 0.1 percent in December as economic activity was hampered by the coldest weather seen in the month in a century, the Office for National Statistics said today.

The inflation outlook has prompted investors to bet on a rate increase. The implied yield on June short sterling futures has risen 25 basis points this year to 1.14 percent. The pound has gained against 15 of the 16 most traded currencies in that period.

First to Raise

Forty percent of investors in a Bloomberg Global Poll last month said the Bank of England will be the first major central bank to raise its key rate, with 27 percent backing the European Central Bank and 20 percent the Federal Reserve.

“The bank doesn’t like surprising the market and a rate rise would put a rocket under sterling, so they want to prepare the ground a bit,” said Ian Kernohan, an economist at Royal London Asset Management. “There is a danger that inflation expectations move higher if the bank doesn’t remove some of the stimulus. We are expecting rates to rise, but not this month.”

Recent data suggest the economy’s 0.5 percent contraction in the fourth quarter may have been a temporary setback to the recovery, adding strength to Sentance’s and Weale’s argument. Surveys last week showed services and construction rebounded in January, while manufacturing grew at a record pace.

‘Finely Balanced’

Britons’ inflation expectations for the next year rose last month to the highest level since 2008, Citigroup Inc. said on Jan. 28. The minutes of the January meeting show that the rate decision for some members was “finely balanced.” Data on gross domestic product for the fourth quarter were published Jan. 25.

“Underlying economic activity might be a bit stronger than we were thinking,” said Philip Rush, an economist at Nomura International Plc in London. “On the basis of the fourth quarter looking like a one-off shock, you could well see another member, maybe more, change their mind and join Sentance.”

Rush sees a 20 percent chance of a rate increase today, and a one-in-three chance of a move in May.

For now, higher inflation expectations haven’t fed through to pay deals. A report from VocaLink today showed wage growth at Britain’s biggest listed companies slowed to 0.6 percent in the three months through January, the least since June.

Still, former official Julius said yesterday that the high rate of inflation still poses risks.

“I think there is a credibility problem,” she said in an interview. “We could well see that our high inflation gets embedded into parts of the wage-bargaining system.”

To contact the reporter on this story: Svenja O’Donnell in London at sodonnell@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

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King Faces Ticking Clock Interest Rates as Inflation Soars

Chris Ratcliife/Bloomberg

Mervyn King, governor of the Bank of England.

Mervyn King, governor of the Bank of England. Photographer: Chris Ratcliife/Bloomberg

Feb. 10 (Bloomberg) -- David Bloom, global head of currency strategy at HSBC Holdings Plc, talks about the outlook for Bank of England interest rates and his strategy for the pound. He speaks with Andrea Catherwood on Bloomberg Television's "The Pulse." (Source: Bloomberg)

Feb. 10 (Bloomberg) -- Kathleen Brooks, research director at Forex.com, talks about the outlook for Bank of England interest rates and her strategy for the pound. She speaks with Mark Barton on Bloomberg Television's "Countdown." Forex.com is a unit of currency trading company Gain Capital Group LLC. (Source: Bloomberg)

Feb. 10 (Bloomberg) -- Michael Amey, executive vice-president for U.K fixed-income at Pacific Investment Management Co., talks about the timing of Bank of England interest-rate increases and his gilts strategy. He speaks with Francine Lacqua on Bloomberg Television's "On The Move." (Source: Bloomberg)

Feb. 9 (Bloomberg) -- Former Bank of England policy maker DeAnne Julius talks with Bloomberg's Scott Hamilton about the outlook for U.K. economic growth and the risks of inflation worsening. She speaks in London following an event organized by Fathom Financial Consulting. (Source: Bloomberg)