As we all know, the Bank of England has said that it will not even consider raising interest rates until the unemployment rate has dropped beneath 7%. We now know that moment will come far sooner than expected. As you can see on this chart, in August, the Bank wasn’t expecting rates to come down towards that 7% level until at least late 2016. Now, the Bank expects that moment to come at the end of 2014.
Now, on the basis of this chart you might well assume that the Bank will start raising rates as soon as the end of 2014 – before the 2015 General Election(!) But don’t be so sure – the Bank is also duty bound to consider what happens to inflation.
Currently investors expect rates to start rising in early 2015 and to hit about 1.7% by late 2016. This morning the Bank told us that if that were the case, growth would be weaker and inflation would be below target at that point. The chart below compares its expectations for what would happen to inflation if rates rose and what would happen if they remained unchanged.
And below is the same chart for broader economic growth (eg comparing GDP growth in the event of rate hikes with GDP growth in the event of no rate hikes):
Why do these comparisons matter? Because in the Inflation Report press conference this morning Mark Carney said he could conceive of unemployment getting down below 7% and the Monetary Policy Committee deciding to leave interest rates on hold specifically because to lift them would both dent economic growth and would push inflation below target.
So what does this all mean? My take is it’s a signal that interest rates may indeed rise before late 2016, but if they do it won’t be by as much as the market currently expects. The problem with relying on this is that the economic picture is changing so quickly. About six months ago it still looked as if the UK was facing a triple-dip recession. Now the economy is in the full swing of recovery.
PS The data in all of these charts come from the Bank of England’s own spreadsheets produced alongside the Inflation Report today. I have tended to use the mean rather than the mode or median.
Update 15:39 – I’ve changed the scale on the chart so that it goes down to zero, rather than focusing on the range between 6% and 8%