Mark Carney said UK interest rates may need to rise at a steeper pace than previously thought to prevent the Brexit-weakened economy from overheating.
The Bank of England lifted its forecasts for economic growth yesterday and said that inflation is projected to remain above the 2% target under the current yield curve, which prices in about three quarter-point hikes over the next three years. The governor noted that a key challenge is sluggish output.
“It will be likely to be necessary to raise interest rates to a limited degree in a gradual process but somewhat earlier and to a somewhat greater extent that what we had thought in November,” Carney said in a press conference yesterday. “Demand growth is expected to exceed the diminished supply growth.”
The BoE’s outlook meshes with signs that synchronised global growth will lead to the end of the loose monetary policies pursued by central banks since the financial crisis a decade ago. Concerns that investors might have underpriced the likelihood of higher borrowing costs to keep inflation under control helped spark a global stock selloff in recent days.
The comments boosted market expectations of a UK rate hike as soon as May. Investors are now pricing a 75% chance of such a move by then, up from 55% before the decision. A hike by August is fully priced in, with another increase seen in May 2019. The pound also jumped after the announcement and was up 0.7% at $1.3978 as of 12:13pm London time.
The Monetary Policy Committee sees the UK growing quicker than its sustainable pace through 2020, meaning there’s a greater risk of overheating, according to the minutes of its latest meeting published yesterday.
Since the vote to leave the European Union in June 2016, the BoE has said it could tolerate faster inflation driven by the weaker pound to support growth. While it had previously stretched its horizon, seeking to return inflation to target over three years, the stronger growth projection means they are now aiming to get inflation to the goal in two years.
Policy makers also reiterated that a range of Brexit outcomes are still possible. Those developments “remain the most significant influence on, and source of uncertainty about, the economic outlook,” they said in the Inflation Report. The BoE left its benchmark interest rate unchanged at 0.5%. The vote was unanimous, though there was speculation that one or two of the nine policy makers would vote for a hike.
“The big question for the Bank of England this meeting was whether the steepening of the yield curve since November would be enough to curb the stronger growth outlook. The answer, Carney and his colleagues think, is no. Bloomberg Economics expected a rate hike to come in August, this strengthens our conviction and tilts the risks to May rather than November,” said Dan Hanson of Bloomberg Economics.
In its updated forecasts, the BoE sees growth at 1.8% this year and next, up from its November projections. While consumption will remain weak and Brexit is damping investment, global demand is helping UK trade, it said.
The central bank cut its estimate of the equilibrium unemployment rate, or the lowest level of joblessness that won’t trigger quicker wage gains, to about 4.25% from 4.5%. The current rate is 4.3%.
It warned there’s little spare capacity left to burn, and the economy’s speed limit, or the rate it can expand without fanning inflation, has dropped to about 1.5% since the Brexit vote.
Because of that, all the slack left in the economy will be eroded within two years and excess demand will then start to build.
In a letter to Chancellor of the Exchequer Philip Hammond explaining why the inflation rate had deviated from target, Carney wrote “the prospect of a greater degree of excess demand” had “further diminished the tradeoff” that policymakers could accept.

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