Hunt for rates clue in Bank report

Wednesday 13 August 2014

The Bank of England will publish its latest outlook for the UK economy today, with its forecasts likely to be seized on for any signs that interest rates might rise by the end of this year.

Britain's recovery to pre-recession levels after six years in the doldrums has driven expectations of a hike, which were intensified by remarks from Bank governor Mark Carney in June.

Mr Carney said in his Mansion House speech that the first hike from the historic low of 0.5% could come sooner than markets were expecting at the time.

It prompted analysts to bring forward their forecasts for a rise to February, though some have pencilled in an increase for as early as November.

The City will seize on the Bank's projections on growth, inflation and the labour market in today's quarterly Inflation Report for the latest clues about when the hike looks likely to come.

Attention is also expected to focus on weak wage growth which, despite continuing improvement in gross domestic product (GDP) and jobs numbers, is increasing at just 0.3% according to latest figures, well behind inflation at 1.9%.

Latest official employment and pay data is due to be published by the Office for National Statistics (ONS) shortly ahead of the report.

Analysts expect the Bank to cut its outlook for pay growth, after forecasting in May that it would approach 2.5% by the end of this year.

They will also be focusing on its calculation of "slack" or wasteful spare capacity in the economy, which policy-makers want to see fall before hiking rates.

A sharp narrowing of the Bank's estimate of this figure is likely to add to expectations of an interest rate rise this year.

Meanwhile, inflation has been hovering below its 2% target for some months but the projection for its future path could also offer clues on rate-setters' thinking.

The Bank's monetary policy committee (MPC) must consider the risk of low interest rates pushing up inflation in the months to come but weigh that against the danger that a rate hike could hamper the recovery by pushing up borrowing costs.

Figures last month showed GDP had finally surpassed its pre-recession peak of 2008, while the dominant services sector continued to grow, though signs from the beleaguered manufacturing and construction sectors were less encouraging.

Minutes of last month's MPC meeting showed that members were divided over whether an early rate increase would derail GDP growth, though they remained unanimous on leaving policy on hold for the time being.

Interest rates have remained on hold since 2009, when they were slashed to 0.5% to help nurse the economy back to health.

They were again held at this month's MPC meeting though there was speculation that some members might have voted for a rise - which would have been the first split on rates since July 2011.

Wage growth has come into focus as an increasingly important factor in the Bank's calculations because of the conflicting evidence on the wider concept of "slack", which would otherwise appear to be narrowing as jobs numbers improve.

It has prompted some analysts to predict that policy-makers will undertake yet another twist in its forward guidance on the path of interest rates.

Last year, the Bank said it would not consider a hike until the unemployment rate fell to 7%, before ditching the policy when joblessness dropped much quicker than expected. It then adopted the more opaque measure of slack.

The shifts prompted Mr Carney to be dubbed an "unreliable boyfriend".

Investec economist Victoria Clarke said: "We will be looking out for yet another twist to forward guidance in the shape of the MPC placing greater emphasis on wage growth (or the lack of it) in policy setting.

"This could be crucial in determining the timing of the first move on rates. If we see this, expectations for the timing of the first move could be pushed back into 2015."

Societe Generale's Brian Hilliard said: "Given the propensity of Mr Carney to vary the tone of his messages with alarming frequency, the markets will be unsure about whether the governor will change his signals yet again in delivering the August Inflation Report."

Alan Clarke of Scotiabank predicted the picture for wage inflation to be revised down from 2.5% for the year.

"Given the downward surprises in this series since May, we will be lucky to see a reading above 1%."

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