Carney Says Rate Increase Can Wait as U.K. Slack Remains
“The exact timing of first adjustment of bank rate will be a product of the evolution of the economy,” the Bank of England governor told reporters in London as he presented quarterly economic forecasts. “Today’s not the day. There’s additional wasteful spare capacity that can be used up.”
With the key interest rate at a record-low 0.5 percent, Carney is battling rate-increase expectations as Britain’s recovery gathers pace. While he said the U.K. is moving closer to a point that it will need tighter policy, the inflation outlook and risks to recovery weigh against an immediate move.
The central bank said it sees inflation staying close to its 2 percent target over the next three years. It forecasts price growth of 1.8 percent this year and next and 1.9 percent in 2016. The economy will grow 3.4 percent this year, the same as it projected at its last forecasting round, and 2.9 percent in 2015, the BOE forecast.
“It’s very similar in tone and message to February, but the latest data, if anything, show activity has accelerated slightly,” said David Tinsley, an economist at BNP Paribas in London. “When you’ve got your foot flat to the floor and the economy’s accelerating you might think a prudent thing to do is ease off, but there’s no sign of that here.”
Money-market investors pared bets for a 25 basis-point increase after the Inflation Report was published. They see no increase until after April next year, according to forward rates on the sterling overnight interbank average compiled by Tullett Prebon Plc. That compares with bets for the first increase in March before the report was released.
The central view of the nine-member Monetary Policy Committee is that the margin of spare capacity will be broadly closed only at the end of its forecast period in three years. The committee also said the level of slack had “narrowed slightly” in the past three months.
That measure has become a focus for the MPC after a drop in unemployment voided Carney’s guidance for no policy change at least until the rate fell to 7 percent. Data today showed unemployment declined to 6.8 percent in the first quarter.
While Carney’s comments today show he wants to continue his push for loose policy, the report also indicates signs of division within the MPC.
“Most MPC members’ central view” is that the amount of spare capacity in the economy is in the region of 1 percent to 1.5 percent, it said. “There is, however, a range of opinions within the committee and considerable uncertainty around the margin of slack.”
U.K. economic growth accelerated to 0.8 percent in the first three months of the year, and the BOE forecasts expansion of 0.9 percent this quarter. Today’s report said a gradual strengthening of productivity and real incomes “together with growing confidence of companies to invest, should underpin the durability of the expansion.”
The central bank predicts the jobless rate will continue to decline and fall to 5.9 percent in the second quarter of 2016. The BOE also said the medium-term equilibrium unemployment rate will also drop, to about 5.25-5.75 percent in three years. It estimates the current equilibrium rate at 6-6.5 percent.
“The recent strong performance of the U.K. economy has continued,” the BOE said. “The expansion now appears more broadly based than previously estimated.”
Carney reiterated comments he and colleagues have made in recent months, that the first interest-rate increases will be gradual and the eventual peak in borrowing costs will be lower than in previous economic cycles.
The central bank also provided additional information about how it will handle the 375 billion pounds ($628 billion) of gilts it purchased as part of stimulus during the financial crisis. In February, officials said they intended to maintain the stock of assets at least until the first rate increase.
“The MPC is likely to defer sales of assets at least until bank rate has reached a level from which it could be cut materially, were more stimulus to be required,” the Inflation Report said. “Some reduction in the stock of assets could be achieved without active sales, as the gilts in the portfolio mature.”
Carney replied to questions on the BOE’s strategy for addressing a surging property market by reiterating comments that monetary policy is “the last line of defense” on risks from housing. He also said the Financial Policy Committee has adequate tools to address threats.
The BOE also said today that inflation may slow more in the near-term than previously projected because the strength of the pound is “likely to bear down” on price growth. Sterling has increased about 10 percent against the dollar in the past year. The BOE sees inflation averaging 1.7 percent in a year before beginning to accelerate toward the 2 percent goal.