Carney Says Modest Rate Hikes Needed Even as Inflation Cools

Mark Carney said the Bank of England still intends to deliver “modest” tightening after an unexpected economic slowdown derailed an interest-rate hike that investors had anticipated as soon as this month.

The BOE governor spoke after officials kept the key interest rate at 0.5 percent, citing the first-quarter slump, and said inflation will weaken faster than previously thought. While his comments keep the prospect of tighter policy alive, investors sold the pound and reduced their bets on a hike this year.

“We think the momentum in the economy is going to reassert,” Carney told reporters in London. “The Monetary Policy Committee judges that an ongoing, modest tightening of monetary policy over the forecast period will be appropriate to return inflation sustainably to its target.”

Money markets now show the probability of an August increase in borrowing costs as only about 50 percent, and a hike by the end of the year — previously fully priced in — at about 87 percent. The pound, which had been up as much as 0.5 percent before the rate announcement, was down 0.1 percent at $1.3534 as of 2:17 p.m. in London.

“Markets have interpreted today’s decision and Inflation Report as moderately dovish — in our view, this reaction seems somewhat overdone,” said Dean Turner, U.K. economist at UBS Wealth Management. “The pound should recover some of its losses in the months ahead as the data confirms that the first-quarter slowdown was nothing more than a temporary glitch.”

Lower Expectations

Investors reduced bets for a Bank of England interest-rate increase in 2018

Carney was consistently forced to defend the BOE’s communication strategy since February’s meeting, a period which marked something of a roller-coaster ride for investors. A rate increase was widely expected until only a few weeks ago, when the governor cast doubt on such a move and data revealed a near standstill in economic growth.

The majority of the MPC noted the recent weak numbers and said there wasn’t much cost to waiting to assess the economy more fully. The Inflation Report showed that about one quarter-point hike a year will be needed to return inflation to the goal after the first increase in a decade last November.

What Our Economists Say

The BOE isn’t the only central bank to wobble on the exit ramp from the easy money of the past decade, even as the U.S. Federal Reserve sticks to its plan to gradually raise rates.

The European Central Bank may now wait until after June to outline its next steps, while the Bank of Japan recently played down when it will reach its 2 percent inflation target. Sweden’s Riksbank and the Bank of Canada have also revised their tightening expectations.

New Zealand central bank Governor Adrian Orr said in an interview on Thursday that the bank wants to see wages rise and start to drive up prices before it increases interest rates from a record low.

New forecasts from the central bank showed inflation will slow more sharply, falling to the 2 percent target in two years, partly because the pass-through of the pound’s depreciation since the Brexit vote is happening faster. It still sees a small amount of excess demand in the economy by early 2020.

The BOE expects an economic expansion of 1.4 percent this year, down from 1.8 percent in February’s forecasts. It said first-quarter growth will probably be revised up to 0.3 percent from the initial estimate of 0.1 percent. The outlooks for 2019 and 2020 were unchanged at 1.7 percent.

It reiterated that the U.K.’s negotiations to leave the European Union constrain supply, making the scheduled March 2019 split the main challenge for rate setters.

Two MPC members wanted to increase rates this month, citing the strength of labor market, where unemployment is the lowest since the 1970s and wage growth is picking up, fueling domestically generated inflation. Still, their colleagues opted not to rush.

“If you’re in a world where you have limited and gradual rate increases over time, you have some flexibility on the timing of when you do those,” Carney said.

Courtesy : Bloomberg
Photo : Medium

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