Market View: Interest rate rise could be in 2017

The BOE’s latest inflation report said that after hitting 0.5 per cent in December, “inflation is likely to fall further in the near term, and could temporarily turn negative”.

The central bank said three quarters of the fall in inflation seen last year was due to “unusually low contributions from energy, food and other goods prices”, and it expects such downward trends to continue into 2015.

The report was accompanied by the release of Bank of England governor Mark Carney’s first open letter to the chancellor following falling inflation.

In this letter the governor explained to George Osborne that the low levels of inflation have mostly been driven by global factors, including the sharp fall in oil prices since June 2014 and that policy will be set so that inflation will likely return to the 2 per cent target within two years.

Sam Alderson, economist at the Centre for Economics and Business Research

The think-tank believes that CPI inflation should “pick up noticeably” towards the end of this year.

A period of negative inflation due to price falls of a few essential items is unlikely to lead to a deflationary spiral and general and persistent declines in prices. Mr Alderson added that the current bout of weak inflation is “likely to boost consumption” as falling prices for essential items raise household spending power, particularly if wage growth continues on its current upward trend.”

Lower oil prices are also likely to “support a recovery” in global growth following the recent weakness, which should further support the health of the UK economy.

“In fact the Bank now expects stronger GDP growth and lower unemployment over the next three years than in its previous forecasts from November last year.”

The report also suggested that the MPC could cut rate further or expand its asset purchases.

“Still, CEBR don’t expect that the Committee will be required to wield these policy tools and will instead act to normalise interest rates as inflation moves within sight of the 2 per cent target in the first quarter of 2016.”

Ben Brettell, senior economist at Hargreaves Lansdown

With regard to the outlook for interest rates, the Bank was “predictably vague”, noting that changes in circumstances could lead to rates rising more slowly or more quickly than currently expected.

“The closest we got to a forecast was that the Monetary Policy Committee believes it more likely than not that interest rates will rise during the next two years.

“Throughout the aftermath of the financial crisis, predictions of interest rate rises have been repeatedly kicked into the long grass. Financial markets now expect a first interest rate hike in early 2016, but I believe late 2016 or even 2017 is the more likely outcome.”

Vicky Redwood, chief UK economist at Capital Economics

Whereas the MPC previously expected inflation to trough at 1 per cent in the first quarter of this year, it “is now more likely than not that CPI inflation will dip briefly below zero at some point in the first half of 2015”, Ms Redwood flagged up in the report.

“However, Mr Carney downplayed the significance of this – in fact, the fall in oil prices and market interest rates has prompted the MPC to revise up its growth forecasts for 2016 and 2017 and it thinks that any slack in the economy will be eliminated by the middle of the forecast period.”

Accordingly, it expects inflation to be back at its target at the two year policy horizon and to be slightly above it during the third year.

“This suggests that markets had gone too far in expecting rates not to rise until Q3 2016. Indeed, in the press conference, Mr Carney seemed to condone the adjustment in rate expectations since the Bank’s forecasts were finalised (markets now expect the first rate hike to come earlier on in 2016).

“With the MPC fairly relaxed about the prospect for deflation, we still think there is a reasonable chance of a hike before the end of this year.”

peter.walker@ft.com