Carney hints at gradual rates rise
Bank of England Governor Mark Carney appeared to play down the prospect of imminent interest rate rises today.
Giving evidence to the Treasury Select Committee, Mr Carney said there seems to be "more spare capacity in the labour market than we previously had thought".
Although the recovery is entrenched and business investment is rising, earnings growth is not as strong as expected - reducing concerns over inflation.
The comments follow mounting speculation that interest rate rises could be brought forward, after Mr Carney warned the markets are underestimating how long it would be before they move off the historic low of 0.5%.
The Institute of Directors (IoD) this morning called for the first increase to happen this year, potentially as early as the autumn.
But Mr Carney said: "The best collective judgement of the MPC (the Bank's Monetary Policy Committee), which I share, is that there is additional spare capacity in the labour market that can be absorbed further before we would look to begin to normalise interest rates, in other words raise interest rates.
"We are looking to manage monetary policy to achieve the inflation target in a way that supports a durable expansion.
"In doing so what we are looking to do is use up, make sure the economy absorbs is a better way of putting it, what is wasteful spare capacity, spare capacity concentrated in the labour market."
Mr Carney added: "We think, and this is the guidance we have given, that that will require the start of normalisation of interest rates, in other words increases in interest rates. The exact timing of that will be driven by the data.
"But the most important aspect of the guidance we are giving is that our view is that the increases in rates over the forecast horizon in our best estimation will be limited and gradual."
The Governor declined to give any guidance on the date when the first interest rate rise might come, but told the committee he expects the base rate to remain "materially below" its historic average of 5% for at least the next three years.
He also indicated that he does not expect the Bank of England to start unwinding quantitative easing (QE) until after interest rates have risen above 1%. The Bank would not want to move on QE until the rate was at a level "that it could be materially cut if we needed to provide stimulus", he explained.
Mr Carney had indicated in his Mansion House speech on June 12 that the first interest rate rise may come "sooner than markets currently expect", leading many observers to speculate it could arrive by the end of this year.
But he told the Committee today the intention of his comment was to shake the markets out of fixed expectations that any rise would not come for a considerable period and remind them they should be reacting to the emerging economic data. The subsequent tightening appeared to indicate he had been successful in this aim.
He was accused by MPs on the committee of sending mixed messages on the future course of interest rates.
Labour's Pat McFadden told him: "It strikes me the Bank is behaving a bit like an unreliable boyfriend - one day hot, one day cold - and the people on the other side of the message are left not really knowing where they stand."
Committee chair Andrew Tyrie said that since he became Governor in 2013, Mr Carney had given "quite a lot of guidance, not all of it seeming to point in the same direction".
But Mr Carney insisted the Bank had been "absolutely consistent" in its approach of offering advice that any rise in interest rates would be driven by data on how the economy is performing and would be "limited and gradual".
"Interest rates are going to start to normalise at some point," he said. "We can't tell you today exactly when that is going to be. It will be determined by the evolution of the economy. We have to watch the data for when that comes.
"But the first interest rate increase is not the most important thing. It is where the path of interest rates are set over the medium term. Our best judgement is that the increase in rates is likely to be limited, relative to history, and the process is likely to be gradual, in order to ensure that what has now been a successful recovery is turned into a durable and balanced expansion.
"That is the guidance we have given. That in our opinion, my opinion, has helped support outcomes... that have been the strongest in the G7 over the course of the last year.
"Our view in terms of where interest rates are going to settle out if you look at a three-year horizon, my personal view is they will still be materially below historic averages - that is, materially below the 5% historic average - because there are huge forces still operating in this economy from the weakness in Europe, the repair of public balance sheets, the weight of debt on private households and the changing financial system."
Explaining the thinking behind Mr Carney's Mansion House comments, Bank deputy governor Sir Charles Bean told the Treasury Committee: "We were all struck by the high degree of certainty that market participants seemed to have about the timing of the first increase in interest rates.
"Market participants, in our view, under-estimate the extent of uncertainty that's out there. Implied volatilities on a range of assets seem to be unusually compressed, at below pre-crisis averages. That doesn't reflect the degree of uncertainty there is - geo-political risk, economic risk and so forth.
"Recognising, and putting into the public domain, the fact that there is that uncertainty about the environment which has an immediate carry-across to monetary policy decisions, I think, was important to do."
Mr Carney's original forward guidance on interest rates last year led to the widespread expectation that a hike would not come until 2016 at the earliest.
The governor told MPs today that subsequent developments had shown that he was "obviously wrong" in his predictions about the path of unemployment rates, which fell faster than he had expected.
Mr Carney told the committee that there were signs that the recovery was becoming more balanced, but cautioned that exports were still lagging behind.
"There are signs that there is more balance in the recovery than previously," he said. "This recovery started out as a sharp increase in consumption, financed by a fall in the saving rate and the initial signs of life in the housing market.
"What has happened subsequently to that is that business investment has picked up. It is contributing about a quarter of the growth rate now."
On exports, he said: "There are still reasonable challenges there, given the weakness of demand abroad and the recent strength of sterling, which hasn't yet been supported by improvements in productivity and competitiveness."
He held out hopes for a pick-up in wage increases, which have lagged behind inflation in recent years: "We have seen jobs, we have seen spending, but we have not yet seen incomes growing. We expect that to start happening and that would be consistent with a durable expansion."
IoD chief economist James Sproule broke with consensus among business organisations in calling for a rate rise as early as the autumn.
Mr Sproule said in a press release: " Ultra-loose policy successfully lessened the impact of the recession, but as the recovery takes hold it will soon be the time to start taking interest rates to a level where monetary policy can once again become an effective economic lever.
"Ideally this rise in interest rates will be achieved gradually, starting in the autumn of 2014, with an aim of reaching a more normal level, perhaps 3%, by autumn 2015.
"Assessing rate rises on the basis that inflation is projected to stay low misses the point. Monetary policy must be put back on a more normal footing first, and then we can monitor inflation to see if further action is needed."