Mark Carney has presented very weak forecasts for inflation in a dovish quarterly report which pushed back market expectations of a rate rise still further but prompted criticism from economists for being over-optimistic about growth.
The Bank of England governor said on Wednesday that financial markets were right to expect lower interest rates for a long time, giving succour to investors who have been betting the BoE would not lift rates from their historic 0.5 per cent low until autumn next year.
The new forecasts showed growth remaining high next year – at 2.9 per cent - even with what the governor called “the spectre of economic stagnation” hanging over the eurozone and a weakening housing market.
Britain’s economy could continue to grow strongly, Mr Carney said, because pay was beginning to grow faster than inflation, household spending would rise faster than incomes and business investment would continue to rise rapidly.
The BoE forecast that inflation would continue to be depressed by falling commodity prices and cheaper imports and would probably fall below 1 per cent in the next six months. That would force a letter of explanation to the chancellor, before prices crept up to the 2 per cent target “only by the very end of the forecast period” at the end of 2017.
The most important way Britain’s economy could withstand a weaker global outlook, Mr Carney said, was by interest rates staying lower for longer. The BoE is using an assumption that rates would not rise until next October in its main forecasts and would stay 0.5 percentage points lower every quarter than it had thought in its previous forecasts made in August.
“It is appropriate that, while a tightening in monetary policy remains in prospect, markets now expect somewhat easier monetary conditions over the forecast period than was the case three months ago,” Mr Carney said.
When the BoE comes eventually to raise rates, he added, “it is expected to do so only gradually and to remain below average historical levels for some time to come”.
The governor denied, however, that he had a pact with George Osborne, chancellor, to avoid interest rate rises before the election. He said the economic situation and prospects for interest rates would continue to evolve, “but it will be absolutely blind to political timing . . . the only way to be apolitical is to ignore it”.
With the bank inclined not to raise rates, financial markets responded by pushing back their interest rate expectations even further. Before the August inflation report the first rise was expected in February 2015. It is now not expected until September next year, with rates staying below 1 per cent well into 2016.
Economists noted that Mr Carney has repeatedly changed his reasons for keeping rates on hold while maintaining the policy stance. In summer 2013, high unemployment prevented a rate rise; by early 2014 the bank had shifted its focus to other labour market indicators such as number of part time workers, but in August this year, it changed its attention to wages. Now it is the global economy.
With this record of changing the story but not the policy, Richard Barwell of Royal Bank of Scotland, said Monetary Policy Committee members were taking quite a risk.
“For [these forecasts] to make sense, they must be supremely confident either that the current policy stance is not anywhere near as loose at it looks or that the economy and their reputation can withstand an aggressive increase in rates down the line to rein in the boom they could be stoking up.”
Professor Costas Milas of the University of Liverpool noted that in the BoE forecasts which assumed constant interest rates at 0.5 per cent, the inflation rate still only rose to a low level of 2.45 per cent by the end of 2017.
“Yet under the same assumptions, unemployment will be at 4.2 per cent,” he said. He explained that with this low level of unemployment – not achieved since the inflationary early 1970s – “I cannot see how these two figures are consistent with each other”.
Michael Saunders of Citi said: “Even while low near-term inflation makes the timing of the first MPC hike highly uncertain, over time we suspect that the continued tightening in the labour market means that the MPC will need to hike more than markets price in”.
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