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Carney Pledges No Rush to Raise Rate as BOE Focuses on Wages

Bank of England Governor Mark Carney
Bank of England Governor Mark Carney speaks during a news conference in London today. Photographer: Simon Dawson/Bloomberg

Mark Carney pledged that Bank of England officials won’t rush to raise interest rates as he highlighted overseas risks to Britain’s recovery and the weakness of wages.

Speaking after a mixed labor market report that showed the first drop in pay since 2009 and the lowest unemployment since 2008, the BOE governor said Britain’s expansion “faces some challenges.” He told reporters in London that policy makers are focusing on wages, and share a similar view to investors on the path of interest rates being “gradual and limited.”

“Geopolitical risks have intensified, and structural adjustment continues in the euro area, where growth is expected to be modest,” Carney said, as he presented the BOE’s quarterly economic forecast. “Pay growth has been remarkably weak, even as unemployment has fallen rapidly.”

The pound fell to the lowest since June against the dollar as Carney revealed the latest thinking of officials pondering when to start withdrawing emergency stimulus. The Monetary Policy Committee is balancing how to respond to a strengthening economy against overseas threats, below-target inflation and subdued earnings.

“The path of bank rate implied by market yields, and on which this forecast is conditioned, rises by only 15 basis points per quarter and reaches only 2.25 percent by the end of the forecast period,” Carney said in London. “Those rate expectations stem from the persistence of the headwinds facing the economy.”

The pound fell 0.6 percent to $1.6706 at 1:28 p.m. in London. The two-year gilt yield declined 8 basis points to 0.73 percent.

Policy Split

The BOE kept its key rate at a record-low 0.5 percent last week. Speculation among forecasters is mounting that it is on the verge of a split, and the committee said today it has a “wide range of views” on the amount of slack in the economy.

Before the report, investors were betting the BOE would increase rates in February, forward contracts for the sterling overnight interbank average, or Sonia, showed. That’s now closer to May.

Investors’ expectations have moved around this year after Carney appeared to give conflicting signals on the timing of the first increase. He said in June speech investors were underpricing the risk of a policy tightening this year, then softened his rhetoric at a parliamentary hearing two weeks later. That prompted one lawmaker to say his behavior was like that of an “unreliable boyfriend.”

Spare Capacity

In the Inflation Report, the BOE lowered its forecast for wage growth and said it will put more weight on earnings in its policy assessment. Data today showed wages fell an annual 0.2 percent in the second quarter, the first decline since 2009.

“In light of the heightened uncertainty about the current degree of slack, the committee will be placing particular importance on the prospective paths for wages and unit labor costs,” Carney said.

“The MPC does not have a particular threshold for wage growth,” he said. “Rather, we will continue to monitor a broad range of data to assess overall inflationary pressures and the timing of the first increase in bank rate.”

The amount of slack is in the region of 1 percent of gross domestic product, the BOE said, lowering an earlier estimate. While the BOE said spare capacity is being absorbed faster than previously anticipated, it said the pace will slow, which “should curb the buildup of domestic inflationary pressure.”

BOE Forecast

The BOE now sees annual wage growth in the fourth quarter at about 1.25 percent, down from 2.5 percent estimated in May.

“While MPC members may have a wide range of views, on balance they are still willing to place most emphasis on weaker indicators, such as wage growth,” said Elizabeth Martins, an economist at HSBC Holdings Plc. “In light of this, we still think bank rate will not rise this year.”

The weak wage data contrasts with a strengthening labor market, with the unemployment rate falling to 6.4 percent in the three months through June. The MPC said these “conflicting signals have underscored the uncertainty” about spare capacity.

The central bank dropped a line from its previous report that there is scope for more slack to be absorbed before rate increases begin. Still, it retained its view that when the MPC starts raising the key rate from a record-low 0.5 percent, the pace of tightening will be gradual.

It also lowered its estimate for the current medium-term equilibrium unemployment rate to about 5.5 percent. That compares with a previous estimate of about 6.25 percent.

The BOE also forecast that the economy will grow 0.7 percent this quarter, and raised its full-year outlook to 3.5 percent from 3.4 percent in May. It said inflation will remain below its 2 percent target through the forecast period.

“The expansion in output is projected to move to a firmer footing as productivity and real incomes revive,” the BOE said. “The remaining spare capacity in the economy is expected to be absorbed at a slower pace and in the recent past, and some slack is likely to persist for most of the forecast period.”

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