Interest rates could rise by the “turn of the year”, the Bank of England bank governor said, emphasising a rise is needed to return inflation to the 2 per cent target.
In a speech yesterday (16 July) at Lincoln Cathedral, Mark Carney said it is the Monetary Policy Committee’s intention to return inflation to the 2 per cent target in a “sustainable manner within two years”.
Over the last few months, inflation has been hovering either side of 0 per cent, which is its current rate.
Mr Carney said: “I expect that this will involve raising bank rate over the next three years from its current all-time low of 0.5 per cent.
“The need for bank rate to rise reflects the momentum in the economy and a gradual firming of underlying inflationary pressures – a firming that will become more apparent as the effects of past commodity price falls drop out of the annual inflation rate around the end of the year.
“It also reflects the lags in monetary policy, given that the peak impact on inflation of a given adjustment in interest rates is likely to materialise around 18-24 months after the change.”
However, he emphasised that the rate will be “gradual” and limited to a “level below past averages”.
Mr Carney said: “It would not seem unreasonable to me to expect that once normalisation begins, interest rate increases would proceed slowly and rise to a level in the medium term that is perhaps about half as high as historical averages.
“In my view, the decision as to when to start such a process of adjustment will likely come into sharper relief around the turn of this year.”
Earlier this week, Mr Carney told the Treasury Select Committee that the UK is nearing the point where interest rates will rise. Responding to questions, he said: “The point at which interests begin to rise is moving closer... counterbalanced somewhat by disinflation and lots of caveats.”
In yesterday’s speech, the governor emphasised that the degree of a likely rate rise depends on three different factors.
“First are the prospects that sustained momentum in economic activity will wring out any remaining slack. This will require sustained growth above its past average of around 0.6 per cent per quarter.”
He added that while consumer confidence is at its highest level for over a decade, the international risks to the growth outlook remain, citing Greece’s situation and the ongoing slowdown in China, but emphasing that “on balance” the global economy will proceed at a “solid” pace.
Secondly, Mr Carney said domestic costs need to continue to firm. “The recent growth in wages has been stronger than we had expected in May, though most of the upside news was in bonuses, which are a less reliable guide to firms’ future labour costs.
“At a minimum, when taken together with survey indicators that continue to point to solid pay growth for new recruits, recent data give welcome reassurance that the risks associated with a deflationary mindset in the labour market have likely fallen significantly.”