Bank of England Chief: Gradual Rate Rises Will Correct Inflation

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U.K. Wage Growth Strengthens, Unemployment Rate Declines

Mark Carney said gradual interest-rate increases will be enough to get inflation back on track as the Bank of England cut its economic growth forecasts through 2017.

The central bank’s view, published in the quarterly Inflation Report on Wednesday, endorsed investors’ expectations that tightening may not start until the middle of next year. The BOE, which sees inflation returning to its 2 percent target within two years, lowered its 2015 outlook to 2.5 percent from 2.9 percent and said productivity will barely grow this year.

“The most important legacies of the financial crisis are the persistent headwinds which continue to weigh on the U.K. economy,” the BOE governor said at a press conference in London. These require “not only a more gradual rate of increase in bank rate than in previous cycles, but also require levels of bank rate to remain below average historical levels for some time to come.”

With consumer-price growth at zero, the report was accompanied by a letter from Carney explaining the deviation from the BOE’s goal. While the governor said inflation may dip below zero in the coming months, there will be a pickup at the end of the year, and the next move in borrowing costs is likely to be an increase. The BOE rate has been at a record-low 0.5 percent for more than six years.

Growth Slowing

The pound pared its advance against the dollar after the report and was little changed at $1.5678 as of 2:40 p.m. London time. It was at 72.14 pence per euro, down 0.8 percent.

The report give the first insight in to the central bank’s thinking since Prime Minister David Cameron clinched a majority victory in the May 7 general election, with the new Conservative government planning further spending cuts. Carney said interest rates will have to remain low while the U.K. battles weaker global demand and tighter fiscal policy.

The Monetary Policy Committee’s most difficult judgment is calling the pickup in productivity, he said. The central bank sees productivity growth of just 0.25 percent this year, down from 0.75 percent forecast in February, and officials forecast it will remain below past average rates.

Developments in the labor market are a key dividing point on the MPC, and last year Martin Weale and Ian McCafferty were in a minority calling for higher borrowing costs on the prospect of a quicker erosion of slack. They suspended their dissent as inflation slid toward zero, and a revival of price gains could also renew their calls.

“With election uncertainty out of the way and inflation approaching its trough, the period of unanimity on the MPC could shortly draw to a close,” said HSBC Bank economists Simon Wells and Liz Martins. “At least two MPC members will start to vote for an interest rate rise during the summer.”

Economic Forecasts

Data earlier on Wednesday showed the unemployment rate fell to 5.5 percent in the first quarter and annual pay growth was at 1.9 percent. Pay has been slow to increase, and the BOE cited surveys of companies and employees showing they expect “little recovery in pay growth this year.”

Still, Carney gave an upbeat assessment for consumers, saying record-low inflation means real disposable incomes will rise the most since 2007 this year.

In its assessment, the BOE also said it expects first-quarter GDP growth to be revised up to 0.5 percent and sees expansion of 0.7 percent this quarter. While it lowered its 2016 and 2017 projections, it said the outlook remains “solid.” It cut forecasts for business investment, exports and household consumption for this year and next. The outlook is based on the BOE’s benchmark rate rising to 1.4 percent by the second quarter of 2018.

On inflation, the central bank lifted its 2015 forecast to 0.6 percent from 0.5 percent and cut the 2016 forecast to 1.6 percent from 1.8 percent.

Weak Inflation

Officials said there is “little sign” of the U.K. slipping into deflation, though it is ready to cut the key rate or restart asset purchases if needed.

In the letter to Osborne, Carney said the weakness in U.K. inflation is being driven by external factors, particularly the sharp drop in oil prices. The governor is required to write such a letter when inflation strays more than a percentage point from 2 percent.

“In the absence of further shocks, to return inflation to the target, it is necessary to eliminate the remaining degree of economic slack,” he said. The MPC will return inflation to the target “as quickly as possible” after the impact of commodity-price drops fades.

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