The Bank of England said it’s no longer expecting to cut interest rates again this year and indicated that concern about accelerating inflation may even warrant tightening at some point.
With the pound’s weakness pushing up inflation faster than anticipated, Governor Mark Carney and the Monetary Policy Committee said that had “adversely affected” how they balance the needs of the economy. Having lowered interest rates in August in response to the Brexit vote, the committee said its previous guidance on the likelihood of another cut had “expired.”
The central bank now sees consumer-price growth rising above its 2% goal early next year and staying above that level right through its forecast period. It said inflation will be at 2.5% in late 2019, the biggest three-year overshoot it’s ever predicted.
There are “limits to the extent to which above-target inflation could be tolerated,” the MPC said as it kept its benchmark interest rate at 0.25% and its QE programme unchanged.
The pound extended gains after the decision and traded up 1.4% at $1.2479 as of 12:11 p.m. in London. The currency earlier surged after a UK court ruled the government must hold a vote in Parliament before starting the two-year countdown to Brexit.
The BoE also said, in a marked shift of tone from August, that monetary policy could respond “in either direction to changes in the economic outlook.”
Nevertheless, the nine policy makers said that the pound’s impact on inflation will prove temporary and attempting to fully counter it with tighter policy “would be excessively costly in terms of foregone output and employment growth.”
“They don’t really know what’s happening” and “I see this pretty much as a holding pattern,” said former BoE policy maker Danny Blanchflower in a Bloomberg Television interview. “They’re trying to reassure people that they will do whatever’s needed.”
Reflecting the UK economy’s recent strength, the BoE also raised its near-term projections and sees growth of 2.2% this year and 1.4% in 2017. But it lowered its view on 2018 to 1.5%, citing the inflationary squeeze on households and “persistent uncertainty” over the UK’s negotiations with the European Union.
The BoE’s acknowledgment of the economy’s recent strength leaves Carney open to further criticism from pro-Brexit campaigners, who’ve accused him of being too gloomy on the potential fallout from the referendum and talking down the economy.
In its analysis yesterday, the BoE said output growth was expected to be stronger this year, “reflecting the resilience in particular of indicators of household spending and sentiment.”
But with the weaker medium-term view, the overall level of output growth will still be slightly lower over the forecast period than anticipated in August.
The bank also published an analysis of the impact of the weaker pound on exports. It said the size of the effect wasn’t certain as it would depend on how companies anticipate the EU negotiations will unfold.
The MPC voted unanimously to keep the key rate unchanged, maintain the gilt-purchase target at £435bn and the corporate-bond purchase target at £10bn. Ian McCafferty maintained his opposition to the gilt plan and Kristin Forbes to both asset programs, though they voted to keep them running as reversing them could have a negative impact.