Britain hints at 2015 rate rise on bullish economic outlook

Bank of England vows to focus on the slack in the economy after it revises upwards UK growth forecasts for the next three years

PUBLISHED : Thursday, 13 February, 2014, 1:24am
UPDATED : Thursday, 13 February, 2014, 4:13am

The Bank of England hinted that interest rates may need to rise in just over a year after it sharply revised up its forecasts for economic growth over the next three years.

It also announced an update to its "forward guidance" policy laying out the likely path for rate changes, saying it would focus on a range of measures of the spare capacity, or slack, in Britain's economy.

The central bank said interest rate increases in line with current market expectations seemed consistent with keeping inflation close to its 2 per cent target. It added that markets priced in a first rate rise in the second quarter of 2015.

It stressed that any rate rises would be gradual and the ultimate level of British interest rates was likely to end up well below the 5 per cent average before the financial crisis.

Governor Mark Carney defended the central bank's decision to adopt a forward guidance plan last year, even though the first version was quickly overtaken by a drop in the unemployment rate to which the pledge of low rates was linked.

"Forward guidance is working," Carney said. "Expected interest rates have remained low even as the economy has recovered strongly, uncertainty about interest rates has fallen, and most importantly, [British] businesses have understood the message."

The pound hit a two-week high against the US dollar and British government bond prices fell after the central bank's announcement.

The Bank of England was forced into making a new statement on when and how it intends to raise rates by the unexpectedly sharp fall in unemployment since Carney made his first stab at forward guidance in August.

Shortly after arriving from his native Canada, Carney persuaded the other eight policymakers in the central bank to make an unprecedented pledge to keep rates on hold until unemployment fell to 7 per cent. It said that would take three years.

Barely six months later, unemployment stands at 7.1 per cent, and the Bank of England forecast it hit 7 per cent in the three months to January and would sink further to 6.5 per cent by early next year.

Britain's economy has grown at an annualised rate of 3 per cent since August. But output is still 2 per cent below its 2008 peak.

The central bank said room remained for more growth without stoking inflation despite a record number of people in work.

Inflation has fallen unexpectedly rapidly to its 2 per cent target and the Bank of England expected it to dip further to 1.7 per cent by March, before hovering close to 2 per cent for the next couple of years.