News Column

City rules out interest rate rise as Bank baffled over economy

August 14, 2014

Angela Monaghan and Larry Elliott

The prospect of an interest rate rise in 2014 appeared to diminish yesterday after the Bank of England admitted it is in the dark about the true state of the British economy.

The August inflation report laid bare the dilemma over the timing of the rise in the cost of borrowing faced by the Bank's policymakers, struggling to reconcile rapidly falling unemployment and record employment with feeble wage growth.

On the one hand, members of the Bank's rate-setting Monetary Policy Committee revised down their estimate of spare capacity in the economy to 1% of GDP from a May forecast of 1-1.5%, as employment growth rockets. Governor Mark Carney and his colleagues made it clear that borrowing costs - on hold at 0.5% since March 2009 - will have to rise before spare capacity is fully used up.

But on the other hand, wage growth has been much weaker than expected, prompting the MPC to halve its forecast for pay growth to 1.25% by the end of 2014.

With inflation expected to remain just below the 2% target by the end of this year, it means real pay for the average worker in Britain is expected to fall for the rest of 2014, prolonging the squeeze on household budgets.

Carney signalled that pay growth will be crucial to the timing of the first interest rate rise amid conflicting signals.

"Pay growth has been remarkably weak, even as unemployment has fallen rapidly.

"In light of the heightened uncertainty about the current degree of slack, the committee will be placing particular importance on the prospective paths for wages and unit labour costs."

Carney repeated the Bank's well rehearsed line that when rates do start to rise, increases are likely to be "gradual and limited". However, in a warning shot that households accustomed to low interest rates should prepare for higher borrowing costs, he added: "That's an expectation, not a promise."

The pound fell to a four-month low against the dollar after Carney's comments and the weaker outlook for wages, as markets interpreted them as a signal that a rate rise in 2014 is unlikely.

Sam Hill, UK economist at RBC Capital Markets, said: "The clear signal from [the August] report is that the odds of a move before the end of 2014 have reduced further. We retain a forecast that the first 25 basis point hike will be in February 2015."


Governor Mark Carney briefing reporters after the Bank's inflation report cut forecast of wage growth for 2014 to 1.25% Photograph: Suzanne Plunkett/Reuters

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Source: Guardian (UK)

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