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BOE leaves rate unchanged, faces upward pressures from economic recovery

12 April 2014

Xinhua, London :
The Bank of England's (BOE) decision Thursday to leave the Bank Rate at 0.5 percent was expected, but the effects of the growing UK recovery, seen in the labor market, could lead the central bank to raise the rate sooner than it would like.
Economic stability also faces a challenge from rising house prices, threatening a bubble, but the solution that the central bank might adopt would likely be a very different one to raising the Bank Rate.
The last change in the Bank Rate was a reduction of 0.5 percentage points to 0.5 percent on March 5, 2009, an historical low.
At the same time a program of asset purchases financed by the issuance of central bank reserves was begun, which reached 375 billion pounds (about 626 billion U.S. dollars) when the last 50- billion-pound set of purchases was authorized in July 2012.
The situation is now very different.
A robust economic recovery is underway, with growth of 1.9 percent in 2013 and the BOE upping its GDP forecast in February for 2014 from 2.8 to 3.4 percent.
Under these circumstances, the Quantitative Easing (QE) policy now looks to be a stimulant that the BOE no longer needs or wants.
BOE Governor Mark Carney has parked the issue of unwinding the assets purchased under QE, saying it would not be considered until the Bank Rate had risen several times.
Globally, the BOE is closer to the U.S. Federal Reserve, which has begun tapering ts asset purchase program, than it is to the European Central Bank (ECB), whose president Mario Draghi talked this month about the possibility of using an asset purchasing program to stimulate the euro zone economy, which faces a threat of deflation.
The UK labor market is a ready indicator of the strength of the recovery, and one that is closely watched by the BOE, which is still operating its forward guidance policy of targeting 7 percent unemployment as the threshold for a rate rise review.
This was set in August last year, when the joblessness rate was 7.8 percent.
But the UK economy has expanded in every quarter since the beginning of 2013, peaking at 0.8 percent quarter-on-quarter growth in 3Q 2013.
That growth has led to faster-than-expected job creation, and the unemployment rate is now 7.2 percent, well ahead of the BOE's forecast.
Carney said at a parliamentary hearing last month that he believes there is still slack in the labor market, amounting to just above 1.5 percent of GDP, that needs to be taken up.
This leaves him room to keep the Bank Rate where it is, because taking up that slack will have less significant inflationary pressures.
Current CPI inflation, at 1.7 percent in February against a target of 2 percent, provides evidence supporting that policy.  The benign influence of inflation is especially seen in its decline from a recent peak of 2.9 percent in June last year.
Carney can also point to a falling joblessness rate and a falling inflation rate, and indicate a distant date for a Bank Rate rise, though he will not be drawn on a specific time.
But for others there are inflationary dangers lurking in the employment figures, which could prompt an earlier rise for the Bank Rat than 2Q 2015.
ING Bank chief UK economist James Knightley said Thursday in an analysis, "The strength of the growth story coupled with the robustness of the labor market means that, in our view, the risks are increasingly skewed towards an earlier move."
Knightley said that with the economy "possibly growing by more than 3 percent this year while also creating significant new employment, we suspect that wage rates will start to be bid higher as the pool of available labor and the general amount of 'slack' continues to shrink."
Simon Wells, chief UK economist at HSBC Global Research, said the BOE's Monetary Policy Committee (MPC) was not about to raise the Bank Rate, as long as wages did not get out of hand.
He said in a note, "While wage growth is contained and the inflation outlook favorable, we do not think the MPC will tighten."
But the threat remains that rising wages could bring about a rate rise.
There are also threats to financial stability in the housing market.
The UK's housing market recovery has been a substantial driver of economic recovery. As prices rise, householders feel more confident and spend more.
But it also presents a lurking threat to recovery if the housing market overheats.

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