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Bank of England dampens expectations of early rate rise; pound slumps

The Bank of England’s monetary policy committee (MPC) sounded more downbeat in its latest quarterly assessment of growth and inflation. As expected the MPC kept interest rates and its asset purchase size unchanged. However, many analysts were expecting that at least one other committee member would join Ian McCafferty in voting for a 0.25% rate hike in today’s meeting. Instead, the voting pattern was unchanged as in the previous three meetings at 8-1.

In its quarterly inflation report, the Bank slightly lowered its growth forecast for 2015 to 2.7%, having only upgraded it in the August report to 2.8%. The forecast for 2016 was also downgraded and growth is expected to come in at 2.5%, versus 2.6% previously. More importantly, the inflation outlook has deteriorated further since the last report and CPI is expected to rise by just 0.1% by the end of 2015, versus 0.3% in the prior forecast. For 2016, inflation will pick up to 1.2% by year-end, versus 1.5% previously, and is not expected to hit the 2% target until 2017.

The Bank attributed around 80% of the CPI’s deviation from its target to lower energy, food and import prices. But some domestic costs are also subdued, which have helped keep core inflation close to 1%. In a surprise move, the MPC indicated in the minutes that they would prefer for inflation not to overshoot the 2% target and therefore set monetary policy in accordance with meeting the target in “around two years” time instead of “within two years” as previously. This implies the MPC is not planning to loosen policy to accelerate the time it takes for inflation to rise to its target.

A slower-than-expected rise in wage growth and the impact of sterling’s appreciation on prices persisting for a longer period than initially forecast were also cited as reasons for inflation taking longer to return to its target.

What was also unexpected was the projected drag on growth from the downturn in emerging market economies. Unlike the US Federal Reserve, which at its last meeting downplayed the downside risks from recent events in China, the Bank of England appeared more worried about the effects to the UK economy from slower growth in emerging markets.

However, domestic demand is expected to remain robust on strong consumer spending and rising real incomes, as well as falling unemployment. Spare capacity in the UK economy should therefore be absorbed over the next year.

The Bank provided no future guidance on when they expect to start raising interest rates but did state that they used the Bank Rate forecasts as implied by market yields, which currently points to no increase in rates until 2017, for their latest outlook. This suggests that, based on current growth and inflation projections, the Bank is comfortable to keep rates on hold until at least 2017.

The minutes once again stressed that when rates do start to go up, the path will be more gradual and lower than recent cycles. Regarding the size of the Bank’s asset purchases, the MPC said they would only start to reduce the stock from the current £ 375 billion when interest rates have risen to around 2%.

The pound slumped by around 1% against the dollar and the euro after the minutes as the BoE’s dovish stance took the markets by surprise. Recent strong data had suggested that the BoE was getting closer to lift-off. Sterling fell from 1.5390 dollars to hit a low of 1.5222 dollars and recovered only marginally in late European session. The euro surged from 0.7061 pounds to 0.7149 but later retreated to 0.7132 pounds.

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