Bank of England says UK recovery is firing up and admits falling unemployment could open door to early rate rise

The Bank of England has brought forward its expectation for when unemployment will hit 7 per cent to the end of 2014 - suggesting interest rates are likely to rise earlier than it has previously flagged.
But the Bank stressed it was in no hurry to hike rates in its latest quarterly Inflation Report, in which it also hiked its growth forecasts for the UK economy.
Nevertheless, markets are now pricing in a 40 per cent chance of a rate hike in two years, up from around 35 percent on Tuesday. The pound rose to $1.6003 against the dollar, up from around $1.5918 before the release of the report, amid expectations that an earlier rate rise is now on the cards.

Rates watch: Bank of England Governor Mark Carney welcomed signs of economic recovery

Governor Mark Carney committed in August to keep interest rates at a record low 0.5 per cent until unemployment fell to 7 percent - something the Bank predicted at the time could take three years.

But financial markets - which were sceptical about the unemployment forecast - have been pricing in a rise in Bank interest rates around early 2015.
Data published earlier today showed Britain's unemployment rate fell to 7.6 per cent in the three months to September, edging close to the Bank's threshold.

 

Carney said today that a fall in unemployment would not be an automatic trigger for an increase in interest rates. 'One could imagine scenarios where the unemployment threshold is reached and that the best policy choice, policy option, for the MPC at that period of time is to keep rates at current levels because the trade-off between output and inflation is attractive', he said.

He hailed signs of recovery, saying: 'For the first time in a long time you don't have to be an optimist to see the glass is half full. The recovery has finally taken hold.
Carney added: 'The MPC is very comfortable with the guidance we put in place. This is the right policy for a recovery and the type of recovery we are experiencing right now.
'We're providing the confidence to businesses and households that we will not even begin to think about moving interest rates until that threshold is achieved. And secondly when it is achieved will be a question of how much momentum the economy has and its ability to withstand an adjustment in monetary policy.'

Jobs growth: Bank of England says the probability of unemployment falling to 7 per cent has increased since August

'Let's say we didn't have forward guidance in August... the discussion would be "Is the Bank going to raise rates today?" No one is asking that question today, and rightly so, because that would be foolish, that would put us in a position of taking a recovery which is finally taking hold and basically pulling the rug out from under it.'
The Bank said that its central forecasts were now all based on market interest rate expectations, but that did not mean that it believed these rate expectations were correct.
Nonetheless, on this basis it expects inflation to fall below its 2 per cent target at the start of 2015 - six months earlier than it had expected in August.
Mr Carney was asked about house prices which have risen significantly since the summer  - the Halifax and Nationwide house price indices rose by 8.1 per cent and 5.8 per cent respectively in the year to October.
He said that the Bank, through the Financial Policy Committee, would be 'vigilant about potential risks there but we need to put the pickup in housing activity in perspective'. ‘We don't make policy at the Bank of England for inside the Circle Line', he added.

'We don't make policy  for inside the Circle Line' - BoE Governor Mark Carney

He said that activity levels were still running at between two thirds or three quarters of historic averages in terms of transactions, approvals and homebuilding. He said there was 'some room for that to further pickup'.
The Bank's report acknowledged that recent rises have meant 'house prices have risen slightly relative to earnings, suggesting a reduction in affordability'. However, it added that 'this ratio nevertheless remains well below the levels reached in 2007'.
It said current low interest rates meant 'income gearing' - the cost of regular mortgage repayments and interest as a proportion of disposable income - remained relatively low. Any risks posed by recent housing market developments will be addressed in the Financial Stability Report due later this month, the Bank said.

Affordable: The Bank said affordability measures remained below 2007 levels.

The Bank also revised up its growth forecasts for this year and next. It sees 0.9 per cent growth in the last three months of 2013, taking full-year growth up to 1.6 per cent compared to 1.4 per cent forecast in August. For 2014 it expects annual growth of 2.8 per cent, compared to 2.5 per cent predicted in August.
Britain's economic output remains well below pre-crisis levels, however, unlike in most other major economies, and the belief that there is a large amount of unused capacity in Britain is what makes the BoE want to keep rates on hold.
Unlike private-sector forecasters, most of the Bank's rate-setters are convinced that weak labour market productivity will rebound sharply as growth picks up, allowing rapid expansion without creating much extra demand for workers.
The unemployment rate was nearer 5 percent before the financial crisis, and deputy governor Charlie Bean suggested last month that the 7 per cent threshold could be lowered if domestic inflation pressures appeared muted.

Rate forecasts: Bank of England shows how the money markets have brought forward rate hike expectations

Capital Economics said the Inflation Report provided some support for market expectations that interest rates could rise some time in 2015, rather sooner than the Bank of England suggested in August.
But its chief European economist Jonathan Loynes said he believed rates will remain on hold rather longer than the markets expect, primarily because inflation will remain weak.
He said: 'We fear that Mr Carney and colleagues will have their work cut out to prevent market rates from rising further - potentially adversely affecting the economic recovery - if unemployment remains on its recent downward trend.'
John Longworth, director general of the British Chambers of Commerce, said: 'The improved outlook is testament to the resilience of businesses across the UK in the face of continued economic challenges.
'With the 7 per cent unemployment threshold now likely to be reached earlier, we hope that Mark Carney will continue to reassure the business community that this is simply an indicator and will not automatically trigger an increase in interest rates.
'Any decision to tighten monetary policy must depend on a lasting improvement in economic conditions.'

When will interest rates rise? The Bank of England's November inflation report shows money markets suggesting mid-2015 and economists later that year.

Azad Zangana, European economist at Schroders, said: 'Given the update in views and analysis from the November Inflation Report, the Bank of England appears to be turning more hawkish, although it also continues its non-committal stance to its 7 per cent unemployment rate threshold. 
'On balance, this leads us to bring forward our forecast for the first interest rate rise from the end of 2016, to the start of 2016, but we are not confident enough in the sustainability of the recovery to forecast tightening monetary policy in 2015, especially due to the poor productivity growth seen.
'The UK’s recovery has considerable momentum going into 2014, but whether the debt fuelled housing recovery translates into anything more than a short-term rebound in demand is questionable, particularly in the absence of wage growth outpacing inflation.'