Economy & Finance

Better outlook poses challenge for Bank of England’s rates message

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LONDON (Reuters) – The Bank of England faces the tricky task this week of upgrading its economic and employment forecasts without stoking speculation in markets that interest rates will rise anytime soon.

The BoE took a new approach to coaxing Britain’s economy back to health in August when it when it made a fall in unemployment central to its thinking about when to raise interest rates from their record lows.

Since then, Britain’s recovery has exceeded expectations and outpaced most other rich economies, fuelling speculation that the BoE might have to move faster than it thought.

Growth of 0.8 percent in the third quarter beat the 0.5 percent penciled in by the Bank’s Monetary Policy Committee and unemployment in the latest quarter fell to 7.7 percent, below the rate of 7.9 percent expected by the BoE.

If that weren’t enough, inflation – long the bugbear of Britain’s economy – has also fallen slightly faster than predicted, helped by a pound which has risen more than 3 percent in trade-weighted terms over the past three months.

For the Bank, which has spent most of the past six years explaining why its forecasts have been too optimistic, this is undoubtedly positive news.

But it throws up a different challenge: how to acknowledge the improved outlook without triggering a rise in bond yields that could itself jeopardize the recovery.

A rise in U.S. Treasury yields was one reason the Federal Reserve balked at the idea of slowing its bond purchases in September, in what would be a first step towards normalizing monetary policy in the United States, where benchmark interest rates have been at nearly zero since late 2008.

“The issue for the Bank of England is how to present their new forecasts without looking foolish,” said Brian Hilliard, UK economist at Societe Generale. “The bottom line is that the Bank doesn’t want to raise rates.”

The Bank said in August it would not consider raising rates until unemployment had fallen to 7 percent. At the time, it did not expect this to happen before mid-2016. This week it will have to acknowledge that it could is likely to happen sooner.

Very short-term interest rates, which form the basis of lending costs in the economy, show markets are largely pricing in an interest rate hike in about two years’ time with the outside chance of a move sooner.

Analysts polled by Reuters last week expected the Bank would bring its forecast for unemployment to those of private economists and would say the rate is now on course to fall to 7 percent by either Q4 2015 or Q1 2016.

Since he took the helm of the central bank in July, Mark Carney has been on a mission to promote growth and reassure firms and households that monetary policy won’t be tightened prematurely.

At a news conference after the release of the Bank’s forecasts on Wednesday, Carney is likely to reiterate that the 7 percent unemployment threshold is a “way station” rather than a trigger for rate hikes.

He might even float the idea of lowering the threshold – say to 6.5 percent – though a change to the forward guidance framework so soon after it was launched would raise eyebrows.

As it did in August, the Bank has invited City economists to a private briefing after the release of the new forecasts when it will have another chance to get its message across.

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