"Fearful fiancé" Carney forestalls a rate rise

Governor of the Bank of England Mark Carney has allayed fears of an earlier-than-expected interest rate rise, insisting that "economic headwinds" including weak wage growth are still a threat to the UK economy.

Delivering the Bank of England's (BoE) quarterly inflation report, Carney hinted that an interest rate rise before the end of this year was unlikely, as there were still "a lot of uncertainties to contend with".

However, the BoE upgraded its 2014 growth forecast to 3.5% from 3.4%, and forecast growth of 3% in 2015, up from 2.9%.

As Kathleen Brooks, research director at Forex.com notes, this is a marked departure from the tone of Carney's February address, when he warned markets that interest rates could go up 'earlier than expected'.

Unreliable boyfriend

"Carney was called an unreliable boyfriend for his switch in tone towards rate hikes, but, in fairness, I would say he is more like a fearful fiancé. He has popped the question (i.e. put the prospect of a rate hike out there), but is yet to commit to a date for the big day," says Brooks.

Wage inflation was of prime concern to Carney and the BoE's Monetary Policy Committee (MPC), which halved its forecast for average wage growth over the next year to 1.25%.

This followed the release of official figures showing that average wages excluding bonuses grew by just 0.6% in the three months to the end of June. This is the slowest rate of growth since records began in 2001 and of extra concern due to falling unemployment.

In addition, the MPC said that spare capacity - a measure of economic underperformance related to a lack of business investment - in the UK economy has fallen to 1% from an estimated 1.5% in February.

"The economy is returning to a semblance of normality, but whether normality in terms of real wages returns will depend on improvements in productivity," says Carney, hinting that he would be reluctant to increase interest rates, putting pressure on inflation while wages were not keeping pace.

Wage growth weakness

Commenting on the the BoE's report, Abi Oladimeji, head of investment strategy at Thomas Miller Investment, says: "Arguably, the persistent weakness in wage growth alongside a sharp decline in the unemployment rate suggests that the medium to longer term equilibrium level of unemployment may be lower than widely thought.

"This is essentially what the Bank of England now thinks and this argument would support the MPC's view that the unemployment rate can move a lot lower without generating significant inflationary pressure."

Carney concluded his address by insisting that should interest rates rise, they would do so slowly.

"What we are putting emphasis on is the path of interest rates, which is limited and accommodative," says the governor.

This largely confirmed market expectations for a rate rise of 0.25% in February next year, taking the BoE base rate to 0.75%. However, Neil Williams, group chief economist at Hermes, warns Carney may have to move sooner than he would like.

"With GDP growing and about to be revised higher, inflation troughing and the MPC mindful of bubbling house prices, the first 25 basis point hike could come sooner, at least to borrowers. Even then though, Carney couldn't be clearer that the MPC will take only baby steps to normalisation.

"Nonetheless, planting the flag early should help Carney make sure the peak rate is materially lower than the BoE's 5% historic average. I expect him to cap it at 3%, supported after 2015 by selling back the gilts bought under quantitative easing, taking further cash out of the system," says Williams.

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