Bank of England governor Mark Carney has suggested an interest rate hike is more likely this year if wage growth outstrips expectations.
Rates could go either way though, he says.
Speaking to the press after yesterday’s launch of the Bank’s inflation report and monetary policy update, Carney said the Bank has assessed the resilience of the UK economy after the latest interest rates cut and saw that the economy could cope with interest rates being held at record lows.
He says: “We can see scenarios in either directions [rates hike or cut]. We have made some important assessments in this forecast on the excess capacity in the economy[…] The economy can run with a policy not adjusted.
“But we’ll find out more about the accuracy of that if the economy continues to grow and if there is higher wages and wages stays higher there could be an adjustment [of rates].”
But he adds if wages grow faster than expected then a rate rise might be needed, though he cautioned his remarks were “not a signal”.
The pound had fallen to $1.2548 at one point during Carney’s press conference, down 0.9 per cent from its earlier highs.
Despite a fall in unemployment, growth in wages has been broadly stable in recent quarters, coming in at 2.3 per cent in the fourth quarter of 2016, the Bank’s February inflation report notes.
Carney adds: “One of the differences between now and November is that the market has started to see some interest rates increase adjustments of the last few years. The direction [of the BoE] will be relative on the market path of rates we are already in.”
The Bank has upgraded its forecasts for growth for the next three years, to 2 per cent this year, 1.6 per cent in 2018 and 1.7 per cent in 2019.
After the Brexit vote, it cut the forecast was 0.8 per cent, while the bank’s November growth forecast was for 1.4 per cent.
To justify the big difference in the forecast from 0.8 per cent to 2 per cent, Carney says while “getting it right” on the effectiveness of monetary policy and global growth predictions, the Bank missed the strong consumption growth in the months following the EU referendum.
He says: “What went right was the policy action taken by the Bank and government to support 2017. Our sense in terms of macro and monetary policies had more traction and impact than expected. Also global economy has been stronger.
“[However] we missed the strength of consumer spending. It has been present throughout all this process after Brexit. It bounced back very quickly and you don’t see that in the data. Consumers have not been effected by any of the associated market uncertainties following Brexit.”
The Governor says this is understandable because the labour market has stayed strong through the period and credit remains available and cheap.
Carney adds: “The consumer dynamic will adjust this year. In the very near term we anticipate less of an adjustment. But as you progress in 2017, real income is slowing down if our forecasts are correct.”
Tough decisions ahead
Aberdeen Asset Management chief economist Lucy O’Carroll says Carney should keep forecasts anchored to the economy’s status as well as deal with developing tensions within the committee over how much inflation can be tolerated before rates are hiked.
He says: “Carney has used today’s events to signal that the bank’s next interest rate move will probably be a hike. It’s hard to understate how much of a turnaround that is from where we were in the immediate aftermath of the EU referendum. The Bank’s post-referendum rate cut was an attempt to pre-empt a downturn that hasn’t occurred.
“But Carney has built the case for a rate rise on a set of big assumptions that may not come to pass. In particular, the assumptions about wage behaviour are based on the view that the labour market continues to act as it has in recent years. But if the prospect of Brexit slows migrant labour flows, for instance, then Carney’s assumption is holed under the water line.