Expectations the Bank of England will begin increasing interest rates in 2014 surged over the past month after Governor Mark Carney cautioned that investors were underestimating the risk, according to a Bloomberg survey.
Thirty-four percent of economists say the BoE will raise the benchmark rate from a record-low 0.5% by December, up from 12% in early June, the survey of 50 economists shows. The poll also finds half predict the first increase will come in the first quarter of 2015, compared with 43%.
Carney’s warning on June 12 that a 2014 rate increase was more likely than the market was anticipating fueled a jump in the pound and a shift in bets on the cost of borrowing, with Sonia contracts now fully pricing in a quarter-point rise by February. While he later softened his comments, the strength of the recovery may produce a majority vote on the Monetary Policy Committee to start withdrawing stimulus by year-end, say economists at banks from Societe Generale SA to Commerzbank AG.
“When you put the markets under starters’ orders you’ll introduce uncertainty if you don’t do anything for six to nine months,” said Brian Hilliard, an economist at Societe Generale in London. “What’s striking is how the U.K. seems to have gone its own way compared to the euro zone. The recovery has still got legs.”
Seventy-seven percent of economists in the poll, which was carried out July 4-10, say the U.K. economy has achieved “escape velocity,” up from 71% last month and 40 percent at the end of 2013. Carney used the term in September last year to describe the strength of growth needed for the economy to withstand higher rates.
The debate over the timing of the first policy tightening in seven years comes with Britain heading for its strongest growth since 2007 -- and the fastest in the Group of Seven -- after a 0.8% expansion in the first quarter.
The Bank for International Settlements echoed Carney’s initial remarks on market pricing. Jamie Caruana, general manager of the Swiss-based institution, said in an interview with the Daily Telegraph newspaper published today that investors had become convinced rates will remain low and “may be taking more assurance than central banks wish to give.”
While weaker-than-forecast U.K. manufacturing, construction and trade data for May cast doubt over whether Britain’s economy sustained its momentum in the second quarter, a report this week is forecast to show unemployment falling to a 5 1/2-year low of 6.5% in the three months through May, and surveys suggest staff shortages are edging wages higher.
“The U.K. economy is growing robustly, house prices are surging and labor-market slack is diminishing,” said Duncan de Vries, an economist at NIBC Bank NV in The Hague. “Against this background, and with Carney telling the markets that macroeconomic developments will dictate monetary actions, what else can market participants do than anticipate bank rate hikes?”
Mitigating the case for action: average earnings are still growing at less than 1% a year and inflation probably stayed below the 2% target for a sixth month in June, with the pound’s 13% gain against the dollar over the past year expected to put further downward pressure on consumer prices.
Short sterling futures point to a possible rate increase by year-end, with the implied yield on contracts expiring in December rising to 0.82% from 0.73% since Carney’s Mansion House speech. By contrast, European Central Bank stimulus is driving down yields in the euro (CME:E6U14) region. The spread between U.K. and German two-year bonds reached its highest since 2008 this month.
The pound (CME:B6U14) has gained almost 11% in the past 12 months, a performance matched only by the New Zealand dollar (CME:N6U14) among 10 major currencies tracked by Bloomberg Correlation- Weighted Indexes.
BoE officials have committed to keeping the key rate at 0.5% until slack in the labor market is used up, preferring to use macroprudential tools to tackle the housing market, where prices rose about 10% over the past year and by almost 20% in London. The Financial Policy Committee took its biggest step yet last month by limiting high loan-to-income mortgages.
Eighty-six percent of economists surveyed say the FPC took the right action, while 46% say the bank will need to do more to prevent households building up risky levels of debt. A record 87% say the housing market is at risk of overheating, compared with 85% in last month’s poll.
“One key assumption to their basic outlook is that house price increases will moderate next year,” said Armela Mancellari, an economist at Barclays Plc in London. “If we observe substantial acceleration in house-price inflation, they might start thinking of introducing more measures, or making the current one tighter.”
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