Better than expected demand in the economy and lower long-term potential for the economy mean interest rates will more quickly than expected six months ago, Mark Carney has said
Speaking before the Treasury select committee today (21 February), the governor of the Bank of England acknowledged the central bank had previously said it expected two interest rate rises in the UK in the next three years, but it has now changed this forecast to three rises over the same time period.
Mr Carney said there was a "much better" outlook for the global economy and a "somewhat better" outlook for the UK economy now compared with just three months ago.
He said the models the Bank of England uses to forecast future movements of prices in the economy have shifted and now predict an "excess of demand" in the economy over the next two years.
Excess of demand over supply is positive for economic growth in the short-term, but pushes prices up, leading to inflation.
Mr Carney said the job of the Bank of England was to strike a balance between keeping interest rates low enough to support economic growth and preventing inflation from getting too high.
He said this balance "has shifted" in recent months, with preventing higher inflation becoming more important than supporting growth.
Putting interest rates up might be expected to cause higher unemployment, as it reduces the level of demand in the economy.
But Andy Haldane, chief economist at the Bank of England said told the committee more jobs might be lost by delaying a rate rises for too long lost by rates rising too quickly.
He said the Bank of England’s current policy aims to put rates up slowly, rather than be forced into harmful rate rises later.
Mr Carney said the expectation was that UK rate rises will be implemented at the rate of three in the coming three years as long as there were signs of wage growth, GDP growth of at least 1.5 per cent a year and inflation above the Bank’s 2 per cent target.
He expected UK growth of 1.75 per cent this year, and expected wages to grow by more than the inflation this year.
The 1.5 per cent growth rate being viewed as the trend level above which interest rates rise indicates the Bank of England expects the long-term trend growth rate in the UK economy to be lower than has historically been the case.
Mr Haldane said the contribution to GDP from population growth will be around 0.5 per cent a year, around half the previous level. He expected productivity improvements to contribute 1 per cent annually to growth, about twice the level of the past decade, but half the historic level.
An excess of demand in the economy that is greater than the expansion of supply, as reflected by productivity improvements and population growth, is inflationary, and requires rates to rise.