2014 UK interest rate rise?
Is a 2014 UK interest rate rise on the cards? Bank of England Governor, Mark Carney, signaled on Thursday that a rate increase “could happen sooner than markets currently expect,” which analyst see as an indication that it could happen this year.
Even though the Bank of England (BoE) will take action to cool the housing market, Mr. Carney emphasized that it will not be a substitute for a gradual increase in interest rates. His hawkish comments pushed the pound to $1.6981 and €1.251, a five-year high. Shares in real estate and housebuilding companies fell.
The governor was responding to the Chancellor of the Exchequer’s (George Osborne’s) speech, also at Mansion House on Thursday, in which he said he was acting to “give (today) the Bank of England new powers to intervene and control the size of mortgages compared to family incomes and house values.”
In May, the governor had warned that the UK’s greatest risk to financial stability and long-term recovery was its housing market, which has deep structural problems that need to be addressed as soon as possible.
Last week, the International Monetary Fund (IMF) warned that risky mortgages have the potential to trigger a credit-led bubble in the UK. House price inflation is becoming more widespread and is particularly noticeable in London, the IMF added. If the current steady acceleration in the size of new mortgages in relation to borrower incomes continues, more and more households will become vulnerable to sudden changes in interest rates or income.
Rate hike forecast brought forward again
In 2013, the UK central bank governor said rates would stay at 0.5% until 2016. As the economic recovery gained momentum financial markets started talking about 2015. His speech on Thursday has definitely brought expectations of a UK interest rate rise further forward.
In a keynote speech at the Lord Mayor’s Banquet for Bankers and Merchants of the City of London at the Mansion House, London, Mr. Carney admitted that speculation was growing regarding exactly when the first rate hike from a 320-year record low of 0.5% might occur. He added that the decision is becoming more balanced.
Mr. Carney explained that the Bank of England (BoE) is now faced with the challenge of turning the current economic rebound, which has steadily gained momentum and breadth over the last twelve months, into a durable expansion. “To do so, we need balance,” he said.
Spare capacity eroding
Mr. Carney stressed that the BoE was not on any pre-set course to raise rates at a certain date. Despite falling unemployment, jobs growth and nearly 4% GDP (gross domestic product) growth, there is still spare capacity in the economy that must be used up first, he explained.
However, economic growth has been much stronger and unemployment has fallen much more rapidly than either the BoE or anyone else had expected, Mr. Carney added. He believes the spare capacity will be eroded much faster than earlier forecasts.
In April 2014, unemployment in the UK fell to 6.6% compared to 7.1% at the beginning of February, while the number of active adults (adults in work) rose to a record 30.5 million (345,000 increase). Most of the new jobs were full-time positions.
Timing less important than pace of subsequent hikes
When the first rate rise occurs is not as important as how rapidly subsequent increases are made, Carney reiterated.
Mr. Carney said:
“The MPC (Monetary Policy Committee) has rightly stressed that the timing of the first Bank Rate is less important than the path thereafter – this is, the degree and pace of increases after they start. In particular, we expect that eventual increases in Bank Rate will be gradual and limited. That is because the economy will face the ongoing challenges of public and private balance sheet repair, a 10% appreciation of sterling over the past year or so, and muted growth in our main export markets.”
“In addition, in the medium term, higher capital, liquidity and other prudential requirements can be expected to lead to higher spreads between borrowing rates and risk-free rates than before the crisis.”
If the central bank does increase rates by the end of 2014, it will be the first major central bank to normalize monetary policy since 2008 when the global financial crisis hit.
Different considerations compared to ECB
A UK hike will probably come six or more months before the US Federal Reserve starts tightening policy. The BoE’s current considerations contrast sharply with those of the European Central Bank (ECB), which reduced rates last week and may have to loosen policy even more in the coming months.
Reuters quoted Lutz Karpowitz, a currency analyst at Commerzbank, who said “The BoE seems to be slightly ahead of the Fed as far as rate hikes are concerned. Macro data is likely to attract particular attention over the coming months. Anything pointing towards a possible rate hike would then support the pound further.”