LONDON (Reuters) — The Bank of England
said on Wednesday British interest rates could start to rise from
record lows in little more than a year as a rapid recovery brings
the economy closer to operating at full steam.
Governor Mark Carney — forced to ditch a previous version of rates
guidance after it was overtaken by a sharp fall in unemployment — also announced the Bank would now follow a much broader range of
measures of slack in the economy in making rates decisions.
The BoE slashed interest rates to 0.5 percent at the height of the
financial crisis in 2009. The economy bounced back strongly last
year but remains smaller than before the crisis and Carney stressed
any increase in rates would be gradual.
"The message to businesses, to households is that the Bank rate is
going to follow a path that is consistent with jobs, with incomes
and with spending growing in a sustainable way," he
said. "We are going to calibrate it carefully. We are not going to
take risks with this recovery."
The central bank said a view in financial markets that rates could
rise in the second quarter of next year — around the time of a
national election — was consistent with its goal to keep inflation
close to its 2 percent target.
It also pointed to market expectations that its interest rate would
stand at 2 percent in three years' time, a timeframe supported by a
Reuters poll of economists taken after the BoE announcement.
Sterling hit a two-week high against the dollar and British
government bond prices fell after the Bank's announcement as
investors added to bets on a rate hike next year.
The Bank said it will focus on 18 separate measures of the spare
capacity in Britain's economy, including business surveys and the
number of hours worked, something economists said would make it hard
to guess the BoE's next moves.
The array of indicators contrasted with the guidance adopted by the
BoE last August when it said it would consider whether to raise
borrowing costs only once unemployment fell to 7 percent.
The jobless rate has since tumbled to 7.1 percent. The BoE forecast
on Wednesday it will reach 6.5 percent in early 2015.
"When Bank Rate does begin to rise, the appropriate path so as to
eliminate slack over the next two to three years and keep inflation
close to the target is expected to be gradual," the Bank said.
The BoE for the first time estimated how much slack is in the
economy — around 1.0-1.5 percent of gross domestic product, lower
than some other economists' estimates.
Deputy Governor Charlie Bean said rates would need to rise before
the spare capacity was completely used up, or the central bank would
risk being behind the curve.
The BoE's dilemma is shared with other central banks in advanced
economies that are healing from the crisis. The U.S. Federal Reserve
is struggling with how to scale back exceptionally stimulative
monetary policy without slowing the recovery too much.
The BoE's latest approach to explaining the policy path ahead
represents a partial return to the situation before the adoption of
forward guidance last year. Then, economists scrutinized small
changes in the Bank's inflation forecasts for signals about whether
policy was too loose or too tight.
How the new estimates of slack will influence BoE inflation
forecasts and its policy decisions could prove hard to predict.
Peter Dixon, an economist at Commerzbank, said spare capacity was a
"nebulous concept" and markets would be hanging on the BoE's
judgments. "We have more clarity about one thing, however — the BoE
is determined to keep rates on hold for a long time to come," Dixon
said.
A further complication is that a rate rise now looks most likely
around the date of Britain's next national election in May 2015, at
which public perceptions of living standards look set to be a key
issue.
In the face of some critical questions from reporters about the
credibility of the BoE's new plan, Carney stuck by the BoE's
decision to launch forward guidance last year.
"Forward guidance is working," he said. "Expected interest rates
have remained low even as the economy has recovered strongly,
uncertainty about interest rates has fallen, and most importantly,
UK businesses have understood the message."
The BoE revised up its growth forecast for 2014 to 3.4 percent from
2.8 percent, a much more bullish forecast than that of most
economists.
Inflation has fallen unexpectedly rapidly to its 2 percent target
and the BoE said it expected it to dip further to 1.7 percent by
March, before hovering close to 2 percent for the next couple of
years.
The BoE said it was now more pessimistic on the outlook for British
productivity than three months ago, as it had failed to keep up with
rises in output. Business investment was likely to pick up but
increasing exports would remain a challenge.
(Additional reporting by Kate Holton,
Andy Bruce, Li-mei Hoang and Paul Sandle; editing by William Schomberg and Jeremy Gaunt)
