Carney Finds Ally in Draghi as Key Rate Kept at 0.5%

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Mark Carney, governor of the Bank of England, left, and Mario Draghi, president of the European Central Bank. Close

Mark Carney, governor of the Bank of England, left, and Mario Draghi, president of the... Read More

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Photographer: Simon Dawson/Bloomberg

Mark Carney, governor of the Bank of England, left, and Mario Draghi, president of the European Central Bank.

Mark Carney has a new ally in his battle to keep Bank of England policy loose: Mario Draghi.

As the BOE’s nine-person Monetary Policy Committee divides between Carney’s view that low rates are still needed and a faction leaning toward higher borrowing costs, events in Frankfurt may favor the governor by weakening the euro against the pound, helping to curb U.K. inflation pressure. The MPC held its key interest rate at a record-low 0.5 percent today and the European Central Bank cut its benchmark and deposit rates.

Britain’s strengthening recovery and a surge in house prices have prompted some MPC members to question how long the key interest rate should stay at a record low. ECB President Draghi had primed investors to expect a new round of stimulus for the euro area and a pickup for sterling would give Carney ammunition in the BOE debate.

“Sterling has strengthened and that would be a force that would keep inflation down, so there’s no immediate need for a rate rise,” said Steven Bell, an economist at F&C Management in London. “The BOE can can sit back and relax with the best-performing economy in the world, watching the ECB pull every lever it can reach to push inflation up.”

Sterling has advanced almost 5 percent against the euro in the past year. It’s gained 9 percent versus the dollar and reached the highest in almost five years last month. A stronger pound eases inflationary pressure by making imports cheaper.

Rate Future

The currency was a focus of the MPC at its last meeting, when officials’ central view was that “nearly all of the recent sterling appreciation would be passed into consumer prices.” It also said pound strength would put “downward pressure” on inflation over the next couple of years. Price growth was 1.8 percent in April, below the 2 percent target for a fourth month.

The BOE’s key rate has been at 0.5 percent since March 2009. Investors are betting the rate will rise 25 basis points by next May, according to forward contracts based on the sterling overnight interbank average. Minutes of today’s meeting will be published on June 18.

The U.K. grew 0.8 percent in the first quarter and is on track to be the fastest Group of Seven economy this year. While there is also a buoyant property market to contend with, Carney says rates are the last line of defense and put the burden on the BOE’s Financial Policy Committee to deal with stability risks. That panel, which he also leads, meets on June 17.

Draghi’s Strategy

The ECB cut its benchmark interest rate to a record-low 0.15 percent from 0.25 percent and lowered the deposit rate to minus 0.1 percent.

Draghi will spell out any further measures to tackle the brewing risk of a negative price spiral at a press conference at 2:30 p.m. in Frankfurt. Euro-area inflation slowed to 0.5 percent in May, less than half the central bank’s goal.

The ECB’s key interest rate is currently at 0.25 percent and policy makers are debating a cut of 10 or 15 basis points in both the benchmark and deposit rates, according to two euro-area central bank officials. The Governing Council is also considering measures including liquidity for banks.

Draghi flagged in May that action was likely, saying that the ECB was “comfortable” with acting this month to boost inflation. The pound advanced about 1 percent against the euro since then, and a further gain may stay the hand of any BOE officials concerned about keeping policy at emergency settings.

Investor Expectations

Draghi has also cited currency moves as a factor in his thinking. He said in March that the euro is “increasingly relevant in our assessment of price stability.” and policy makers blamed a strong currency for weakening price pressures.

Nick Beecroft, senior market analyst at Saxo Capital Markets in London, said the euro may already reflect expectations for measures such as a 15 basis-point cut in ECB rates. Now that Draghi has flagged the Governing Council’s concerns on the currency, a bigger drop may only be possible if officials take more dramatic steps to lift prices.

“The market has realized that the ECB is really focused on the euro, and they will want blood,” he said. “They’ll want deeper cuts in the deposit rate or quantitative easing before the euro weakens further.”

(An earlier version of this story corrected the time of the ECB policy decision.)

To contact the reporter on this story: Jennifer Ryan in London at jryan13@bloomberg.net

To contact the editors responsible for this story: Craig Stirling at cstirling1@bloomberg.net Fergal O’Brien

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