Bank of England edges closer to interest rate rise

The Bank of England signalled it is edging closer to a rise in interest rates but admitted it is in the dark about the true state of the British economy.

Policymakers at Threadneedle Street used the August inflation report to revise down their estimate of spare capacity in the economy, to 1% of GDP, from its May estimate of 1-1.5%.

Governor Mark Carney and his colleagues on the Bank's rate-setting Monetary Policy Committee have made it clear that the best time to increase borrowing costs – on hold at 0.5% since March 2009 – will be before spare capacity has been fully absorbed.

The MPC said it expected the bank rate to remain below pre-crisis levels of around 5% for some time to come but said that it could offer no guarantees because of the uncertainties surrounding the economy.

Carney reiterated that when rates do start to rise, increases will be "gradual and limited." However, he cautioned: "That's an expectation, not a promise."

The governor highlighted a range of risks facing the UK economy, including heightened geopolitical tensions, a weak recovery in the eurozone, and UK household indebtedness.

He said: "Even if spare capacity was absorbed at a stroke overnight, Bank rate would not be far from where it is today because of these headwinds."

The August report laid bare the dilemma faced by the MPC, which is trying to reconcile rapidly falling unemployment with very weak wage growth.

The MPC sharply revised down its forecasts for pay growth, predicting average wage rises of 1.25% by the end of 2014 - half its May forecast of 2.5%.

With inflation expected to remain just below the 2% target by the end of this year, it means real pay is expected to fall for the rest of the year.

Unemployment, meanwhile, is forecast to move below 6% by the end of 2014.

The City is likely to interpret the August report as a signal that the MPC is becoming increasingly divided about the appropriate timing of the first rate rise.

The Bank noted in the report: "Not surprisingly, there is a wide range of views on the committee about the likely degree of slack. Uncertainty about how much slack there is has increased in recent months, in part reflecting labour market out turns."

The bank revised up its growth forecast for 2014 to 3.5% from 3.4%, and for 2015 to 3% from 2.9%. Carney said: "Sustained economic momentum is looking more assured. The economy is returning to a semblance of normality."

Powered by article was written by Angela Monaghan and Larry Elliott, for on Wednesday 13th August 2014 11.44 Europe/London © Guardian News and Media Limited 2010


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