Carney Sees Slow Approach on Rates After First Hike in a Decade
(Bloomberg) -- Mark Carney stressed that any further interest-rate hikes are some way off as he pointed to the fastest inflation in five years to justify the Bank of England’s first increase since 2007.
“It isn’t so much where inflation is now but where it’s going that concerns us,” the BOE governor told reporters after the Monetary Policy Committee doubled its key rate to 0.5 percent. “While the sheer novelty of the first increase in bank rate in a decade creates some uncertainty around its impact, there are reasons to expect it to be no larger than usual.”
Policy makers voted 7-2 on Thursday to increase the benchmark rate, but the minutes of their meeting underscored worries that the economy is fragile as the 2019 date for departure from the European Union nears. The dovish language sent the pound slumping 1 percent to around $1.31.
While inflation is now at 3 percent, a full percentage point above the central bank’s target, some economists have questioned whether tightening policy in the midst of negotiations with EU leaders is a good idea. Crucially, policy makers omitted language from previous statements saying that more hikes could be needed than financial markets expect.
Asked in the press conference whether the rate move might ultimately be viewed as a mistake, Carney said that it was better to think of it as a “nimble response” to an unpredictable set of circumstances.
Once the “big issues” around Brexit have been clarified -- including whether there will be a transitional arrangement and what the end state will look like -- policy makers must “step back and assess the new outlook and calibrate policy appropriately.”
The language in the minutes implies that officials are comfortable with pricing by investors for two more quarter-point increases, roughly one by late next year and another in 2020. U.K. money markets pushed back expectations for the next shift by one month to September 2018.
“Interest rates are likely to rise only very gradually over an extended period of time,” said Colin Ellis, managing director for credit strategy at Moody’s Investors Service. “This benign outlook for interest rates differs from past monetary cycles, when policy rates rose more swiftly and more sharply after they reached their previous floors.”
Thursday’s decision removes the main emergency stimulus introduced in the wake of last year’s referendum to leave the EU, against a current backdrop of the lowest unemployment in four decades.
The dilemma for policy makers is that underlying price pressures aren’t stemming from stronger demand, but flaws in the economy aggravated by Brexit, namely weak productivity. For the first time, it gave an estimate of the economy’s potential growth, the pace at which it can expand without spurring inflation, setting it at 1.5 percent.
The risk is that inflation soon fades and the hike ends up looking premature.
“We don’t expect that inflation will remain high,” said Michael Pond, head of global inflation market strategy at Barclays Plc. “The hike today, which seems like a good idea, may not be so good in hindsight. It’s a risk of a policy error.”
The bank kept its forecasts for growth and inflation broadly unchanged and sees price gains at 2.2 percent in three years, slightly above its goal. The estimates are based on market projections for the key interest rate reaching 1 percent over that period.
Officials saw relatively steady growth over the next three years -- about 1.7 percent -- but that’s far below the pre-crisis average of 2.9 percent.
The forecasts were accompanied by a gloomy section that there are “considerable risks” to the outlook, with Brexit featuring prominently.
Never in its 20 years of independence has the BOE tightened when GDP growth was so weak. At 0.4 percent in the third quarter, it was a 19th consecutive expansion, but below the average of the past five years.
For the doves on the committee, Deputy Governors Jon Cunliffe and Dave Ramsden, there was little sign of domestic costs and wages picking up and they saw a chance spare capacity in the economy was greater than estimated. Ramsden declined to elaborate on his vote in the press conference.
The rate increase will hit mortgage holders, a fifth of whom have never experienced a BOE rate hike, according to the bank’s estimates. The effect will be gradual overall because so many borrowers are tied to fixed rates, it said.
The decision to hike comes after multiple false alarms from Carney since he took over as governor in 2013, most notably in 2014 when his whipsawing of investors led to him being tagged an “unreliable boyfriend.”
The BOE’s step into tightening territory sets it on a path already well-trodden by the Federal Reserve, although it’s responding to economic strength. After a meeting at the U.S. central bank this week, officials signaled they remain on track to hike for a third time this year in December. The American economy is forecast to expand 2.2 percent this year.
“It’s a relatively unusual period of underperformance for the U.K. at a time when the G-7 is doing as well as it is,” Carney said. “We have certain unique elements here that we’re grappling with.”
©2017 Bloomberg L.P.