The Bank of England gave no sign that it was in any more of a hurry to raise interest rates yesterday, predicting near-zero inflation would pick up only slowly even if borrowing costs stay on hold all of next year.
Sterling fell sharply after the BoE’s announcement, which contrasted with the tone of the US Federal Reserve, whose chair Janet Yellen said on Wednesday that a US rate rise was a prospect for December.
Only one BoE policymaker, Ian McCafferty, voted to raise interest rates this month, as most economists had expected, while the other eight on the Monetary Policy Committee opted to keep them at a record-low 0.5 per cent, where they have been since March 2009.
The BoE trimmed its forecast for economic growth for this year and 2016 and warned emerging markets could get stuck in a rut of slower growth.
There remain downside risks to this outlook
“The outlook for global growth has weakened since the August Inflation Report,” the BoE said in its quarterly forecast update. “There remain downside risks to this outlook, including that of a more abrupt slowdown in emerging economies.”
The central bank also said it would continue to reinvest the proceeds of bonds maturing from the £375 billion of quantitative easing assets that it bought to spur growth until it had raised interest rates to around two per cent.
The BoE message on inflation surprised investors, who in recent days had started to price in a rate move earlier than they had in recent weeks.
Sterling fell more than a cent against the dollar and government bond yields dropped sharply.
Ross Walker, an economist with RBS, said he was sticking with his view that the BoE would raise interest rates in August next year.
“It’s not a radically different signal versus (the BoE’s outlook published in) August, but if the Bank was teeing up a February rate hike, it would not have produced this set of forecasts,” he said.
BoE governor Mark Carney has previously said a decision on whether to raise interest rates would become clearer around the turn of this year.
Financial markets have been betting on a rate hike further out than most economists, and in recent days most money was on a first rate increase at the end of 2016.
The BoE used recent market forecasts of no move until 2017 as its working assumption for its new outlook. It predicted that inflation, currently below zero, would nudge above two per cent in two years’ time on a so-called ‘modal’ projection basis.
This was only a fraction higher than its August forecast, which had been based on rates rising in the middle of next year, the market assumption at the time.
Indeed, a slightly different BoE forecasting basis – which looks at the ‘mean’ outcome for inflation, including downside risks – still saw inflation at the bank’s two per cent target in two years’ time.
Economists have said they expect a first interest rate rise by the BoE in the second quarter of 2016, according to the average forecast in a Reuters poll.
The bank said inflation was likely to stay below one per cent until the second half of 2016, due overwhelmingly to lower costs for energy, food and other imports.
The slow pickup in inflation comes despite relatively robust growth forecasts.
Growth, as measured on a modal basis, is seen at 2.7 per cent this year, 2.5 per cent in 2016 and 2.7 per cent in 2017, only a whisker weaker over the three-year period than the bank predicted in August and above most economists’ expectations.
But the warning on emerging markets may in part reflect the concerns of the BoE’s chief economist, Andy Haldane, who recently warned that China’s sharp stock market falls could prove the start of a third act of the global financial crisis which started in 2008.
Minutes of the MPC’s discussion this month showed there was “a wide spread of views” about the outlook for growth, inflation and the impact of the slowdown in emerging markets.