Carney Keeps Rate at Record Low as BOE Weighs Capacity

The Bank of England kept its key interest rate at a record low today as policy makers try to gauge the amount of spare capacity in the economy.

With the Monetary Policy Committee bound by Governor Mark Carney’s forward guidance, officials held the benchmark rate at 0.5 percent, where it’s been since March 2009. The decision was predicted by all 50 economists in a Bloomberg News survey. The panel’s discussions took place yesterday, cut short by a day to allow some of the nine members to attend International Monetary Fund meetings in Washington.

The MPC met amid signs that the recovery is strengthening, with data this week showing industrial production rose more than economists forecast in February. While Carney has pushed back against expectations of an imminent interest-rate increase, saying more slack needs to be absorbed, the panel is divided over the amount of spare capacity in the economy.

The decision “is likely to have been unanimous again,” said Samuel Tombs, a London-based economist at Capital Economics Ltd, who predicts the BOE will keep rates unchanged until late 2015. “Some of the indicators of spare capacity that are likely to be on the MPC’s dashboard have been flashing red. Nonetheless, other developments are likely to have reassured the MPC that interest rates can remain on hold for a good deal longer.”

The MPC also kept its asset-purchase program on hold at 375 billion pounds ($629 billion), according to a statement released in London by the central bank.

Economic Strength

Under guidance, the MPC has said it won’t consider raising borrowing costs at least until unemployment, currently 7.2 percent, falls to 7 percent. The BOE will lift its key rate by 25 basis points by May 2015, according to one-month forward contracts for the sterling overnight interbank average, or Sonia.

The pound has appreciated more than 9 percent against the dollar in the past year as an improving economy prompted investors to add to bets for higher rates. Sterling slipped 0.1 percent to $1.6774 as of 12:11 p.m. London time, after reaching $1.6823 on Feb. 17, the highest level since 2009.

One potential risk for officials is that leaving rates low for too long creates a spiral in property prices. Policy makers have said they are monitoring for signs of overheating and will use macroprudential measures as the first line of defense. House-price growth accelerated in March and a shortage of homes for sale will keep upward pressure on values, the Royal Institution of Chartered Surveyors said in a report today.

Slack Discussions

Britain’s National Institute of Economic and Social Research estimated this week that economic growth accelerated to 0.9 percent in the first quarter, which would be the fastest in four years. The IMF raised its U.K. forecasts and now sees expansion of 2.9 percent this year.

Still, the economy was 1.4 percent smaller in the three months through December than at its peak in early 2008, supporting the central bank’s view that there is enough spare capacity to keep rates on hold without fueling faster inflation. Niesr said a “sizable negative output gap remains.”

While the bank estimates the level of slack in the economy at 1 percent to 1.5 percent of GDP, that figure has been contested by its own officials, with Martin Weale arguing it may be less and Carney and David Miles suggesting it may be more.

“The slack will be used up more quickly than the Bank of England predicts,” said Philip Rush, an economist at Nomura International Plc in London. “By November there won’t be enough to keep inflationary pressures in check and the bank will have to increase rates.”