Markets pricing in BoE rate rise 2 years early

Financial markets are expecting the Bank of England to disregard its newly introduced policy of forward guidance and increase its base rate as much as two years early.

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Reports in today’s Financial Times say market interest rate expectations suggest the Bank of England will increase base from its current rate of 0.5 per cent towards the end of 2014 or early in 2015, instead of late 2016 as predicted by the Bank.

New Bank of England governor Mark Carney introduced the policy of forward guideance to help give businesses and the financial markets some certainty about when rates would change.

In August, Carney said base rate would remain at 0.5 per cent until unemployment dropped below 7 per cent and the Bank of England said it expected the first increase to be 0.25 per cent towards the end of 2016.

However, with the UK’s economic recovery gathering pace, financial markets now expect the Bank of England to have to act much sooner to prevent the economy overheating.

The at the meeting of the Monetary Policy Committee in July, the Bank of England said it would depart from its policy of linking base rate to unemployment if one of three knockouts was triggered.

The three knockouts are: 

  • in the MPC’s view, it is more likely than not, that CPI inflation 18 to 24 months ahead will be 0.5 percentage points or more above the 2% target;
  • medium-term inflation expectations no longer remain sufficiently well anchored;
  • the Financial Policy Committee (FPC) judges that the stance of monetary policy poses a significant threat to financial stability that cannot be contained by the substantial range of mitigating policy actions available to the FPC, the Financial Conduct Authority and the Prudential Regulation Authority in a way consistent with their objectives.