Interest rates Bank of England warns of interest rate rise over next three years
A rise in growth above 1.5% in 2020 and 2021 would be enough for the economy to begin overheating
Bank of England governor Mark Carney has warned that a modest recovery over the next three years will warrant higher interest rates than financial markets currently expect as inflationary pressures force the central bank to act.
Unlike the European Central Bank and and the US Federal Reserve, which have signalled a significant easing of monetary policy in recent weeks, Carney said investors were under-estimating the likelihood of higher interest rates in three to five years’ time.
A rise in growth above 1.5% in 2020 and 2021 would be enough for the economy to begin overheating and spur the bank’s monetary policy committee to raise rates.
“If something like the forecast comes to pass, it will require interest rate increases over that period [two years] and more frequent than financial markets currently expect,” said Carney.
But the bank’s monetary policy committee said in its quarterly inflation report that it would restrict the pace of interest rate rises over the next two years to no more than a quarter point as Brexit uncertainty and a severe dive in business investment robbed the economy of momentum.
The downbeat assessment of the UK’s immediate prospects came as the central bank voted unanimously to keep interest rates on hold at 0.75% and maintain its £435bn quantitative-easing scheme.
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The Bank raised its forecast for GDP growth this year from 1.2% to 1.5% to take account of a boost to output from Brexit-related stock building, which policymakers predict pushed first-quarter GDP to 0.5%. It said growth would slip back to 0.2% in the second quarter as businesses waited for the outcome of Brexit talks with the EU.
Unemployment is expected to fall over the two-year forecast period to 3.5% – a level not seen since 1973 – and wages are expected to remain well above inflation to give workers several years of real terms increases. However, declining gas and electricity prices, and a weak exchange rate is likely to keep inflation in check, restricting the need to push up interest rates above 1% by 2021 from today’s 0.75%, it said.
“UK GDP growth is projected to decline in the near term. That slowing partly reflects the continued effect of uncertainties around the eventual nature of the UK’s withdrawal from the EU. Uncertainty has had a particularly pronounced effect on business investment, which fell in every quarter in 2018 and is projected to decline further over coming quarters,” the report said.
The Bank also blamed a slowdown in global growth for the weakness of the outlook for the UK and added that business investment was unlikely to return until the dust had settled on the Brexit debate, and then only modestly, in contrast to the Treasury’s forecast of a significant Brexit dividend.
All the bank’s forecasts are based on Britain signing a Brexit deal with the EU and agreeing a transition period that allows businesses to adjust to a new relationship with their largest trading partner.
A majority of exporters have told the Bank’s network of agents they are as prepared for a no-deal Brexit as they can be but they expect leaving the EU without a deal would lead to a loss of trade and a financial hit to their business.
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