BOE’s ‘Game Changer’ Brings Forward Rate-Rise Calls

Bank of England Governor Mervyn King
Governor Mervyn King said the “best collective judgment of the committee is that the chances of inflation being above or below the target” by the end of bank’s forecast period are “broadly equal.” Photographer: Chris Ratcliife/Bloomberg

The Bank of England’s inflation projections prompted economists at banks including Barclays Capital to bring forward their forecast for the first interest-rate increase this year.

Barclays economist Simon Hayes said policy makers are “leaning toward a rate hike over the next few months” after the central bank published its Inflation Report in London.

Hayes, a former Bank of England official, changed his prediction for the first rate increase to May from November, while Hetal Mehta at Daiwa Capital Markets Europe now sees the first increase in August rather than November. She described the report as a “game changer.”

The central bank projected in its Inflation Report yesterday that consumer-price growth will accelerate to about

4.4 percent this year before easing to its 2 percent target by the middle of 2012. Risks are “skewed to the upside,” it said. The outlook is based on its benchmark interest rate rising from a record low of 0.5 percent to 1 percent this year and 2 percent by the end of 2012.

The pound rose against the dollar today after policy maker Andrew Sentance repeated his call for higher interest rates. He also said that the bank can’t be “relaxed” about price pressures related to the weakness of the currency, which has fallen about 20 percent on a trade-weighted basis since the start of 2007.

Sterling appreciated as much as 0.3 percent, and traded at $1.6125 at 11:38 a.m. in London. It also strengthened 0.3 percent against the euro to 84.05 pence.

‘Too Optimistic’

The central bank’s forecasts for inflation to return to target are “too optimistic,” Sentance, who has voted for rate increases every month since June, said in a speech in London today. Policy “‘would most likely need to be tightened faster and by more than the markets currently expect to bring inflation back to target.”

Ross Walker, an economist at Royal Bank of Scotland Group Plc, also revised his rate forecast and sees the Monetary Policy Committee increasing it in May rather than November. He said there is a “modest risk” of a move next month.

“Maintaining policy credibility seems to require some action -- rhetoric is unlikely to suffice,” he said. Still, “it is difficult to see the MPC raising bank rate by much more than 50 basis points given the fragile growth trajectory and the likelihood that inflation is falling back in the second half.”

‘Best’ Judgment

U.K. inflation accelerated to a 26-month high of 4 percent last month, boosted by oil prices and a sales-tax increase. King said the “best collective judgment of the committee is that the chances of inflation being above or below the target” by the end of bank’s forecast period are “broadly equal.”

Investors scaled back their bets on rate increases this year after King said policy makers haven’t preannounced any moves and that “some people are running ahead of themselves.”

“That decision has not been taken and it won’t be taken until we get to the next meeting, or the following meeting,” King said. “It may be many quarters before we do anything.”

The yield on short-sterling futures expiring in December has fallen 8 basis points this week 1.7 percent today.

The Inflation Report “worked to knock down some of the expectations that have built around monetary tightening in recent weeks, even if the specter of a rate hike being delivered at some point during the coming months was not entirely removed,” said Stuart Green, an economist at HSBC Holdings Plc. “Although the upside risks to inflation may eventually force some monetary tightening over the two-year forecast horizon, the uncertain growth environment dictates that no pre-commitment on rates exists.”

“Any move higher in rates is likely to fall well short of current market pricing,” Green said. He maintained a forecast that the bank will not raise its key interest rate this year.

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