Bank of England Governor Mark Carney said on Thursday the decision to raise interest rates from record lows will come into sharper focus around the end of this year, his strongest hint yet about the timing of the British central bank’s next move.
Carney spoke of strong momentum in Britain’s economy and described a slowdown at the start of the year as merely a blip.
But he reiterated that interest rates would rise only gradually from their record low of 0.5 per cent, and to lower levels than in the past.
Carney’s speech puts the British central bank on track to follow the U.S. Federal Reserve by raising interest rates in the near future, after more than six years at rock-bottom levels amid the fallout of the global financial crisis.
“In my view, the decision as to when to start such a process of adjustment will likely come into sharper relief around the turn of this year,” Carney said in a speech delivered at Lincoln Cathedral in east England.
Sterling rose briefly against the dollar as Carney spoke and then slid back. Earlier, the pound hit a 7-1/2-year high against a trade-weighted basket of currencies as traders bet the BoE would raise interest rates early next year.
Carney said there had been a persistent pass-through from sterling’s strength into weak headline British inflation, adding that this was “particularly relevant” as the monetary policies of the euro zone and Britain diverge.
British inflation edged back down to zero last month, a long way from the BoE’s two per cent target.
But Carney said gathering inflation pressures would become more apparent towards the end of the year as the effect of falling oil prices drop out of the annual inflation rate.
“In the scenario of continued evidence of strong wage growth, and an easing in the exchange rate, one interpretation of ‘around the turn of this year’ could become before the end of this year,” said Sam Hill, economist at RBC.
Carney said the prospects for higher rates depended on wringing out the remaining slack in the economy, which would require sustained economic growth of around 0.6 per cent per quarter.
In the medium term, he predicted interest rates would probably rise to a level about half as high as their historical average of around 4.5 per cent.
Outgoing MPC member David Miles on Tuesday suggested the right level of interest rates, to keep inflation on track and demand in line with capacity, would be around three per cent in two years’ time.
Miles, usually regarded as a “dove”, surprised markets by saying it was “likely to be right” to hike rates soon.
There is now a strong possibility that August’s meeting could see a renewed split among the nine BoE rate setters for the first time this year. In the second half of last year, before inflation started to tumble due to lower oil prices, MPC members Martin Weale and Ian McCafferty voted for higher rates.
Carney also acknowledged the risks to Britain’s economic outlook, including its large current account deficit which argued for a “right policy mix” that includes tight fiscal policy.
“Given these considerations, the MPC will have to feel its way as it goes,” he said.