Carney keen to calm rumours of big rate rise
...but hike is expected before the election
WHEN Mark Carney took over as Governor of the Bank of England last summer he indicated interest rates would not rise until 2016. How times have changed. The economy is back within a whisker of the pre-recession peak, unemployment has dropped to a fiveyear low of 6.9pc, and the housing market is booming.
The International Monetary Fund, the Organisation for Economic Cooperation and Development and even Carney himself believe the UK will be one of the fastest growing major economies in the developed world this year. The Canadian will tomorrow concede the turnaround means rates will rise far sooner than previously thought – possibly before the General Election in May next year.
Former Bank economist Rob Wood, who now works at Berenberg Bank, expects ‘tacit acceptance of an earlier rate hike’ from the Governor. ‘The economy is growing rapidly and, if anything, is picking up pace,’ he says. ‘Record low interest rates are increasingly unnecessary. We expect the Bank will admit that a rate hike is coming sooner rather than later.’
Interest rates were cut to an alltime low of 0.5pc in March 2009 under Carney’s predecessor Mervyn King.
The central bank also unleashed an unprecedented £375bn money printing programme, known as quantitative easing, as it battled to stop the Great Recession turning into something even worse.
The stop- start recovery brought speculation about when rates would finally start to rise and return to more normal levels.
But, on his transfer from Ottawa where he ran the Bank of Canada, to his new base on Threadneedle Street in the heart of the City of London, Carney was determined to bring such speculation to an end.
In his first inflation report in the UK in August last year he pledged the Bank would not even consider raising rates until unemployment fell to 7pc – something he did not expect until 2016.
The plan was to reassure households and businesses that rates would not be rising anytime soon – whatever the financial markets suggested. But unemployment fell far faster than anyone expected – not least Carney – forcing the central bank to change its tune.
Many independent observers now believe that the first rate hike since July 2007 will come late this year or early next year.
When the Bank’s latest inflati on r eport i s published tomorrow Carney will struggle to dampen such expectations. Even George Osborne is preparing for a rate rise before polling day on May 7.
The Chancellor insists the discussion around the possibility of higher interest rates ‘is a mark of success’ because it shows ‘we have started to see the recovery take off ’.
But an early rate hike is far from certain.
At the last inflation report in February the Bank said that ‘despite the sharp f all in unemployment, there remains scope to absorb spare capacity further before raising Bank Rate’.
In other words, the Bank believed there was room for the economy to grow even faster and create even more jobs without pushing up inflation – meaning no rise was necessary.
Although the recovery has picked up pace since then, the Bank is likely to stick to its guns tomorrow, arguing unemployment is still too high and many workers are ‘underemployed’.
The other key message that Carney and the monetary policy committee have tried to get across is that when rates do start to rise the increases will be ‘ gradual’ and ‘limited’.
The Bank has specifically said that ‘ even when the economy has returned to normal’ the ‘appropriate level of Bank Rate is likely to be materially below the 5pc level set on
‘The economy is growing rapidly’
average by the committee prior to the financial crisis’.
It is a message the market has taken on board. Although rates are expected to rise late this year or early next year, they are still expected to be around 3pc in 2020 ( seeabove).
The fact that inflation has fallen back below the 2pc target to 1.6pc – a level not seen since 2009 – has eased pressure on the Bank.
A surge in inflation would of course change things – and if wages pick up sharply the Bank may be forced to act earlier than it i s currently planning.
House prices are also causing alarm with Sir Jon Cunliffe, the central bank’s deputy governor in charge of financial stability, describ- ing developments in the property market as ‘the brightest light on the dashboard’.
The Bank hopes that ‘macroprudential’ tools, rather than higher interest rates, will be able to cool the housing market.
Such tools include strict mortgage underwriting standards to curb reckless lending, the threat of limits on loan-to-value or loan-to-income ratios, and changes to rules to force banks to hold more capital against risky home loans.
Matthew Pointon, an economist at Capital Economics, says capping LTIs would be particularly effective because this would have the biggest impact in London where prices are rising fastest.
‘Action to curb loan-to-income ratios will be key,’ he says. ‘But with a high share of cash buyers, the Bank will also need to toughen up its rhetoric to subdue house price expectations. Raising interest rates will be seen as a last resort.’
Karen Ward, senior global economist at HSBC, believes macroprudential policy ‘is a potentially useful complement to monetary policy’. ‘But it is no panacea,’ she adds. ‘Achieving simultaneous long-term stability in growth, financial markets and inflation may be impossible.’
A number of analysts have described the UK as a ‘goldilocks’ economy with growth not too hot and not too cold – meaning rates can remain at rock bottom levels.
But the message from the Bank will be twofold: Rates will have to rise at some point – quite possibly in the next 12 months – but they will remain well below the long-run average of 5pc for years to come.