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BoE increases economic forecasts, signals tougher stance on rate rises
The Bank of England has increased its forecasts for economic growth and signalled that interest rates may rise sooner than it had indicated.
Voting unanimously to leave rates on hold at 0.5% the BoE's monetary policy committee said if the economy performed as expected "monetary policy would need to be tightened somewhat earlier and by a somewhat greater degree over the forecast period than anticipated at the time of the November report". In November the committee only saw the need for two rate hikes over the next three years.
The pound rose in response to the MPC's more hawkish guidance and some economists said the next rate increase could come as soon as May.
The BoE expects the economy to expand by 1.8% in 2018 and 2019 - up from earlier estimates of 1.6% and 1.7% respectively and faster than the "speed limit" of about 1.5% Governor Mark Carney unveiled in November. If the economy grows faster than that pace it is at risk of overheating, the BoE has said.
Carney said the economy was benefiting from faster global growth than the BoE expected, helping to make up for "the shallowest investment recovery" in half a century and weak household spending power. The pound's fall since the vote for Brexit in June 2016 has put exporters in a "sweet spot" to capitalise on global growth, he added.
He said the MPC was not warning that rates would rise faster than previous guidance. "The message is not more rapidly. I would caveat that. It is somewhat sooner and to a somewhat greater extent," Carney said.
The pound rose 0.6% against the dollar to $1.3959 and 0.9% against the euro to 1.1413 at 12:25 GMT.
After consumer price inflation retreated slightly in December to an annual rate of 3.0%, the BoE's quarterly inflation report forecast CPI would ease to 2.16% in two years' time, down from its earlier estimate of 2.21%, despite sterling's recent appreciation. The MPC acknowledged for the first time the risk that "the contribution of imported inflation pressures would diminish more rapidly than in the central projection".
Economist Paul Hollingsworth at Capital Economics said the MPC appeared to be shortening its time horizon for bringing inflation back to target.
"Until now, it has been happy to let inflation overshoot the target even after three years," he said. "However, the minutes stated that 'a more conventional horizon' was now appropriate. Typically, the MPC aims to get inflation back to target over a 18-24 month horizon."
"As a result, today's releases pave the way for an interest rate hike in May, and we think that the MPC will hike a further two times this year, taking Bank Rate to 1.25%."
Barclays splashed a little cold water on the prospects for a May hike but did not dismiss the possibility, looking at the 22 March MPC meeting to bring more insights and clarify the committee's view regarding the appropriateness of market expectations. Economist Fabrice Montagne said: "While that seems to point towards a hike in August, the BoE could also consider a hike in May but would then need to argue much more convincingly that the British economic and political backdrop supports such a step change."
The BoE reported its more optimistic outlook amid renewed volatility in financial markets that have seen shares tumble and bond yields spike. Carney said markets had been extraordinarily calm - until recent days - and suggested it was beneficial for investors to remember that values can go down as well as up.
"It's healthier when markets have two-way risk. In that regard, one hesitates to say 'welcome' but it's not an entirely surprising development."
Carney said the BoE's forecasts assumed a smooth Brexit transition and that leaving the EU was still the biggest source of uncertainty for the economy. The outcome of talks over the next year will have a greater bearing on households and businesses than decisions taken by the BoE, he said.