When doves cry: Bank of England dampens UK rate expectationsContributors Stephanie Flanders, Nandini Ramakrishnan, Global Markets Insights Strategy Team
The Bank of England's (BoE's) Monetary Policy Committee (MPC) voted 8 to 1 to keep rates on hold at 0.5% today, in line with expectations. What was more surprising in this report were the BoE’s new forecasts, which suggested that inflation could remain at or below the target level of 2% for the next 18 months, even on the assumption of no change in the policy rate before the end of 2016. This is markedly dovish in an environment in which the US Federal Reserve and its chair, Janet Yellen, have recently been raising market expectations for a December 2015 rate rise.
Sterling fell by 0.9% against the dollar immediately after the BoE announcements, and by around 1% against the euro. Two-year gilt yields fell slightly and the FTSE rallied in the immediate aftermath, but has since fallen back to end the day 0.6% lower.
The MPC's inflation forecast has been revised down since the summer and shows UK inflation remaining close to zero in the very near term, and below 1% for most of 2016, returning to the 2% target only in 2017. While growth in advanced economies has continued and broadened, BoE policymakers also expect domestic and global growth to be a little slower than they anticipated in their August 2015 meeting.
However, the weaker outlook for inflation and potentially slower timetable for rate rises did not reflect a significantly more negative view of the UK recovery. The BoE's governor, Mark Carney, affirmed that resilient domestic confidence and robust private domestic demand would provide momentum to eliminate the margin of spare capacity in the economy over the next year. Third-quarter unemployment was down to 5.1% and domestic wages have picked up markedly over the course of 2015, reflecting a tightening labour market, and perhaps representing a precursor to domestic inflationary pressures. The challenge for the MPC, according to Carney, was to balance these signs of domestic economic strength against the overseas weakness that had also been evident in the months since the BoE’s last report.
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