Carney Keeps His Cool on Inflation With Surprise Slack Discovery

  • Bank of England lifts growth forecasts, inflation outlook same
  • Governor maintains that next rate move could be up or down

BOE Warns of Brexit Twists as U.K. Continues Growth

Mark Carney is remarkably sanguine on inflation.

While the Bank of England Governor and fellow policy makers see price growth breaching their 2 percent goal as early as this quarter, they said there’s more slack in the economy than previously thought, meaning it’s unlikely to get out of hand.

That’s a less alarmist stance than forecasters such as the National Institute of Economic and Social Research, which sees inflation accelerating to almost 4 percent toward the end of this year. Even other members of the rate-setting Monetary Policy Committee appear to be getting uncomfortable, with minutes of the meeting saying some have moved closer to the limit of their tolerance for above-target price gains.

After leaving policy unchanged, Carney didn’t rule out raising rates before negotiations to leave the European Union begin, though he emphasized that the process of disentangling was only starting and that consumer spending and investment are likely to decrease as the process gets underway.

“In all likelihood the MPC probably wouldn’t want to move before Brexit and our central view is that it likely won’t,” said Philip Shaw, chief economist at Investec Securities in London. The Inflation Report “certainly helps quash speculation of a near-term rate hike.”

Consumer spending has kept the U.K.’s motor running since the June vote, confounding the BOE’s expectations of a sharp slowdown. The U.K. central bank and other economists who predicted an immediate hit to growth came under fire from pro-Brexit campaigners for being too gloomy.

Pound Drop

Now retail sales are starting to slow, however, as the pound’s fall feeds into import prices -- a trend that’s likely to continue this year. And while the U.K. has yet to formally divorce from the EU, it will probably see some reduction in access to the 500 million consumers in the bloc.

Prime Minister Theresa May plans to trigger the formal exit process by the end of next month. U.K. Brexit Secretary David Davis said Thursday that the U.K. will be leaving the EU’s customs union -- which allows exporters to trade freely with the rest of the bloc -- in order to set its own tariffs and negotiate trade deals around the world.

The BOE now sees growth of 2 percent this year, up from 1.4 percent in November. That’s set to slow to 1.6 percent in 2018 and 1.7 percent the following year, the BOE said, slightly faster than it forecast in November.

At the same time, the forecasts for inflation have barely changed. The bank lowered the projection for 2017 to 2.7 percent from 2.8 percent, and kept the prediction for next year at 2.6 percent.

“Absent this reassessment of the supply potential of the labor market, an improved demand forecast by itself would have had much more significant upward implications for the inflation forecast,” said Sam Hill, an economist at RBC Capital Markets in London. “We maintain our view that the MPC is fundamentally in neutral for the rest of 2017.”

Policy makers said there’s more labor supply than they previously assumed, meaning wages -- and therefore prices -- will be restrained. The BOE cut its estimate of the rate that unemployment can fall to without fanning inflation; it now sees that equilibrium rate at 4.5 percent, compared with 5 percent earlier.

Carney said the suitability of the current policy stance depends on three judgments:

  • That the drop in the pound continues to boost consumer prices as expected and doesn’t have adverse consequences for longer-term inflation expectations
  • That pay growth remains modest
  • That household spending slows as real incomes weaken

He reiterated that the next interest-rate move could be up or down, depending on how events play out. Investors appeared to find Carney’s remarks more dovish than they expected. The pound fell about 1 percent.

“Absent this reassessment of the supply potential of the labor market, an improved demand forecast by itself would have had much more significant upward implications for the inflation forecast,” said Sam Hill, an economist at RBC Capital Markets in London. “We maintain our view that the MPC is fundamentally in neutral for the rest of 2017.”

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