Carney’s Speed Limit on Rate Hikes Seen at Once a QuarterScott Hamilton
When Mark Carney finally begins to lift Bank of England interest rates from a record low, his plan for a gradual tightening suggests changes no faster than once every three months.
The Monetary Policy Committee has raised borrowing costs on average every two months since 1997 when in a tightening cycle. To satisfy Carney’s pledge, slower moves than that are likely once increases begin, according to BNP Paribas SA and Societe Generale SA.
While the MPC doesn’t plan to raise rates any time soon, a strengthening economy is spurring debate about when, how much and how fast it will tighten. Investors are betting an increase won’t happen until 2015, and some economists say it could be this year. Carney will share his thinking in two days when he unveils new economic projections.
“Three is a perfectly reasonable definition of gradual and it could even be slower,” said David Tinsley, an economist at BNP in London and a former BOE official. “But gradual is ill-defined. It allows them quite a lot of scope.”
All but one of the 21 rate increases since October 1996 have come in 25 basis-point increments. There have been 26 reductions in the benchmark in that period, once as much as 1.5 percentage points. The rate has been at 0.5 percent since March 2009, the longest stretch of unchanged policy since the 1940s.
Since the MPC published its last forecasts in February, it has used “gradual” to describe the potential pace of tightening. Officials have also said increases will be “limited,” and Carney has said the normal level of rates will probably be lower than the pre-crisis average since the BOE got independence in 1997.
The MPC has said rate increases will come first in any tightening, followed by the sale of gilts it’s built up as part of quantitative easing.
While the pace will depend on the economic and inflation outlook, policy makers will also have to factor in the impact of QE unwinding and any macroprudential measures taken to stem risks from a booming housing market. Interest-rate swaps show the BOE rate will only rise to 2.5 percent in about 3 1/2 years.
There have been four BOE tightening cycles in the past 17 years. The most recent began in August 2006, when the MPC unexpectedly raised the key rate to head off inflation pressures. That series of increases continued until July 2007. Five months later, officials loosened policy as the financial crisis began to take hold.
Carney is battling against rising rate-increase expectations as Britain’s economic recovery strengthens. Growth accelerated to 0.8 percent in the first three months of the year and surveys pointed to continued momentum this quarter.
The Confederation of British Industry raised its economic growth forecasts today and projects expansion of 3 percent this year and 2.7 percent in 2015. The business lobby sees the BOE increasing borrowing costs in the first quarter of next year.
The governor has reinforced his low-rate message in recent months after unemployment fell faster than the BOE had forecast. It’s now below 7 percent, voiding the first phase of his forward guidance. With that framework abandoned, officials’ debate centers on the amount of spare capacity in the economy.
The Chartered Institute of Personnel and Development said today that companies’ hiring intentions are at the highest in more than six years. Data on May 14 may show unemployment fell to 6.8 percent in the first quarter and jobless claims dropped in April, according to surveys of economists.
Rob Wood, a former BOE economist who now works at Berenberg Bank in London, expects a rate increase in the first quarter of 2015, though there’s a 35 percent chance of a rate hike in fourth quarter of 2014.
“Slack is falling, house prices are booming and inflation is close to the BOE target,” he said. “In February, the central bank signaled a first interest-rate increase in the second quarter of 2015 on the basis of a forecast for growth to slow down through 2014. That is not happening.”
In his push for low rates, Carney can look to inflation, which at 1.6 percent is below the BOE’s 2 percent goal. The MPC has also said inflation expectations remain well anchored. Still, against the backdrop of rising wages and falling unemployment, the MPC must be careful not to take chances.
“There is a risk they will move too slowly,” said Brian Hilliard, an economist at Societe Generale in London and a former BOE official. “It’s such a strong burst of growth it will probably require a more dramatic increase in rates, not initially, but a sustained increase.”
While he sees the BOE raising rates in the first quarter of next year with a 25 basis-point increase, and subsequent moves every three months, asset sales and macroprudential tools could be used if greater tightening is needed.
Tinsley at BNP said Carney’s press conference this week could “one small step” on the way to exiting stimulus.
“It’s hard to see how it can be dovish really given what’s going on and weak productivity growth,” he said. “It’s got to be either neutral or interpreted in a hawkish way.”