The pound nudged to a one-month high and the FTSE 100 edged downwards following a warning from the Bank of England that interest rates are likely to rise sooner than the market is currently expecting.
Details published this afternoon show at its latest meeting last Friday, the Bank of England Monetary Policy Committee (MPC) voted by a majority of 7-2 to leave interest rates unchanged.
But the market has been moved by remarks made in the commentary afterwards, where the central bank said if the economy, inflation and employment rate continue at the same level, a majority of the members see scope to reduce the level of stimulus in the economy.
"Monetary policy could need to be tightened by a somewhat greater extend over the forecast period than current market expectations… some withdrawal of monetary stimulus is likely to be appropriate over the coming months," it said.
A central plank of the Bank's attempts to kick-start the economy since the financial crisis has been to hold interest rates at record lows, cutting them again to their current rate of 0.25 per cent in the wake of June's vote to leave the European Union.
Signals from the Bank that it is eyeing a move away from such policies has been interpreted as meaning rates could rise earlier than expected.
Kathleen Brooks, head of research at City Index, noted the Bank of England does not require economic growth or inflation to move upwards from here, just for the path to remain unchanged.
She said the Bank of England seems happy to reduce stimulus from the economy, despite the lacklustre level of economic growth.
Monetary stimulus can be withdrawn from the economy in more ways than just interest rates.
The policy of quantitative easing being unwound by the central bank through the sale into the market of some of the stock of bonds it owns would also serve to tighten monetary policy.
This is because selling bonds on such a scale would push bond yields upwards.
That would mean the interest rate paid to savers and the rate charged to borrowers would rise, which would be expected to reduce spending in the economy, and snuff out some of the inflationary pressures in the economy.
The report from the Bank of England this morning said a majority of the nine-person committee favour some action.
UK interest rates are unlikely to rise until late 2018, despite rising inflation and employment levels, according to James McCann, senior global economist at Aberdeen Standard Life.
He said the UK’s exit from the EU will impact short-term economic demand in a way that reduces spending and has the same effect as tighter monetary policy on inflation.
Mr McCann said the central bank’s rhetoric about rate rises is to give it flexibility in future.
Nancy Curtin, chief investment officer at Close Brothers Asset Management said wages rising at a slower rate than inflation means spending is likely to fall, and as that has the same effect on inflation as tightening monetary policy, the economic arguments to put rates up are “not convincing.”
David.Thorpe@ft.com
