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Bank chief Carney's warning as interest rates stay on hold at 0.5%

Published 05/11/2015

The Bank of England is due to publish its keenly-awaited quarterly inflation report
The Bank of England is due to publish its keenly-awaited quarterly inflation report

Bank of England governor Mark Carney has said he still sees the need for gradual interest rates rises to bring inflation back to target, but latest forecasts signal a hike in the cost of borrowing may not come for another year.

Mr Carney, who previously said the decision on whether to raise rates would come into "sharper relief" around the turn of the year, said the economic picture had changed in recent months as the global economy has slowed.

He warned the outlook for global growth had weakened since the Bank's last inflation report in August and added that there was a risk of a "more abrupt slowdown in China", which could hit UK growth.

His comments follow the Bank's decision once more to keep interest rates at 0.5%, where they have remained for more than six years.

Members of the Bank's nine-strong Monetary Policy Committee (MPC) voted 8-1 to leave rates on hold.

The Bank, which also published its quarterly inflation forecast, downgraded its growth outlook slightly, to around 2.7% for 2015, down from 2.8% previously predicted in August, while also cutting it next year to 2.5% from 2.7%.

The report suggested that rates may potentially not rise until 2017 amid global growth concerns and ultra-low UK inflation.

This would be good news for borrowers, but heap further misery on savers.

The inflation forecast shows that, at the time of report, financial markets had pushed their expectations for a rate rise back from the middle of 2016 in August to the first half of 2017.

This follows on from a summer of market turmoil amid concerns over China's slowing economy.

But yesterday's comments from United States Federal Reserve chair Janet Yellen that a US rate rise in December is a "live possibility" has already seen financial markets bring forward their expectations for the UK to follow suit with a hike at the end of 2016.

Mr Carney also stressed that if rates did not rise until the first half of 2017, inflation is predicted to overshoot its 2% target.

He said: "We are in a situation where we have resilient domestic demand and, even in the face of global weakness, we still see the need for gradual interest rate rises to bring inflation back to target."

He said it was a "reasonable expectation" that rates may rise at some stage within the next year.

The pound fell a cent against the euro and the dollar, at just over 1.40 and just under 1.53 respectively following the inflation forecast.

In giving a downbeat assessment on the global growth picture, the Bank said many emerging economies have slowed "markedly" this year.

It also predicted that UK inflation - which last month slipped into negative territory for the second time this year, at minus 0.1% - would remain below 1% until the second half of next year.

The majority of the Bank's policymakers felt that the more gloomy global growth picture, together with ongoing low inflation, meant rates should continue to remain on hold.

MPC member Ian McCafferty was the sole dissenter for the fourth month in a row, calling for a rise to 0.75%.

There had been speculation ahead of the latest decision that more MPC members would join him in calling for a rise.

Mr McCafferty called for a rise once more, judging that inflation could rise further above the Bank's 2% target within the two-year projection period, according to the minutes of the rates decision.

But most members did not feel inflationary pressures were strong enough.

The Bank also published the latest letter from Mr Carney to Chancellor George Osborne, explaining why inflation is more than 1% off its 2% target.

In it, the governor said: "The single most important reason for below-target inflation remains the sharp falls in energy prices since the middle of last year.

"Oil prices have fallen further over the past three months and in September they were around half the level of a year earlier."

But he added: "In the absence of further falls in commodity prices, inflation rates close to zero are unlikely to endure much beyond the end of the year."

He said inflation would, however, remain below 1% until the second half of next year, meaning "it is likely that I will have to write further open letters to you over the coming months".

In its latest policy decision, the Bank also kept its quantitative easing programme on hold at £375 billion and said it would not begin to reduce it until Bank base rate is around 2%.

The report comes after official figures last week showed a drop in UK growth to 0.5% in the third quarter, from 0.7% in the previous three months.

But robust surveys this week from the services, manufacturing and construction sectors suggests growth may pick up again in the fourth quarter.

Howard Archer, chief UK and European economist at IHS Global Insight, said he believed a rate hike would come sooner than financial markets predict.

He said: "A summary of our view would be that the first interest rate hike from 0.50% to 0.75% is still most likely to happen in May 2016 - but the risks now seem to be that the increase could be later than this rather than before it."

James Knightly, at ING, said: "We remain comfortable with our view that they will start tightening in the second quarter of 2016 - after the Federal Reserve, but well ahead of market expectations."

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