Carney Says Gradual BOE Rate Increases Needed Amid Headwinds

Bank of England Governor Mark Carney said interest-rate increases will be more restrained than in the past as he warned that “extraordinary forces” are still confronting the British economy.

The BOE is supporting the investment needed for growth “through clear guidance that it expects increases in bank rate, once they begin, to be gradual and limited,” he said in a speech in Glasgow, Scotland today. “This is in part because the headwinds facing the economy are likely to take some time to die down.”

The stronger pound, weak demand in key export markets and government budget-cutting are holding back growth, and high household indebtedness underscores the need for caution on the level of borrowing costs, Carney said. While the normalizing economy will warrant higher rates, the Monetary Policy Committee has “no pre-set course” for any increases, which will be determined by economic data, he said.

“None of us should forget the extraordinary forces still weighing on the economy,” Carney said during questions after his speech. “The ‘new normal’ will be materially less than it was previously.”

Sonia forwards show investors expect a quarter-point increase to 0.75 percent by February, with the benchmark rate reaching 2.25 percent by the end of 2017 compared with about 5 percent before the financial crisis.

Conflicting Signals

The MPC will update its thinking next month, when it publishes new economic projections in its quarterly Inflation Report, he said. With the economy heading for a sixth consecutive quarter of growth, officials’ focus is shifting to the timing of the first rate increase in seven years.

Policy makers are balancing “the implications for inflation of hard evidence of sustained economic momentum against conflicting signals over the degree of slack in the labor market,” Carney said.

Wages suggest labor supply is greater than the bank initially expected, while spare capacity is also being used up faster than it first thought, he said. A key point in the assessment will be how this translates into the pace of real pay increases, he said.

Minutes of the bank’s July policy decision published today echo the conflict, with some officials saying there’s less of a risk a rate increase may derail the recovery. Others pointed to a lack of evidence on building inflation pressures, and risks a premature increase would leave the U.K. vulnerable to shocks.

Unanimous Vote

The nine-member MPC voted unanimously to keep the key rate at a record-low 0.5 percent. Officials will use the results of the next quarterly forecasting round, to be published in the August Inflation Report, to assess developments on wages.

The pound fell as investors pared expectations for higher interest rates and was trading at $1.7037 as of 2:30 p.m. in London. Ten-year government bond yields slid to an eight-week low and implied yields on short-sterling futures declined.

Carney said markets may do some of the work for the BOE, with higher spreads on borrowing likely to result from new financial regulations. There is also the prospect of lower rates of global productivity growth and persistent imbalances between savings and investment, he said.

‘Staggering’ Weakness

Achieving balanced growth in the U.K. depends on the fortunes of its trading partners, Carney said.

“Demand from the U.K.’s traditional markets such as Europe is a staggering 25 percent below a continuation of its pre-crisis trend,” Carney said as he stressed the need for exporters to diversify away from “slow-growing advanced economies.”

Net trade acted as drag on growth in the first quarter, with exports climbing just 0.5 percent.

The U.K. should help resist protectionism by spurring new trade deals with the European Union and the U.S. and through bilateral initiatives with India and China, Carney said.

Britain also needs to take a central role in financial reforms, Carney said. The effectiveness of markets and trust in them has been diminished by “widespread rigging” in some areas, he said. Making markets more fair and transparent may require changes to the way they work, more regulation or new codes of conduct.

“We need a simple approach that recognizes that the actions of a few to manipulate, game or profit from unfair access weakens the effectiveness of markets for all,” Carney said. “Such actions hold back prosperity. They should therefore have clear consequences.”

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