BOE Signals Rate Rise as Central Banks Edge Away From Easy Money -- 6th Update

By Jason Douglas and Paul Hannon Features Dow Jones Newswires

The Bank of England signaled Thursday it is preparing to raise interest rates within months to restrain accelerating inflation in the U.K., in the latest sign major central banks are bringing to an end a decadelong era of easy money.

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The BOE's step toward tighter monetary policy comes as the Federal Reserve is poised to start the process of reducing its $4.5 trillion in securities holdings, while the European Central Bank is likely to announce plans next month for phasing out its bond-buying program amid a buoyant eurozone economy.

If all three deliver, it would be the first time they have moved together to withdraw stimulus since adopting extraordinary measures to revive economies scarred by the past decade's financial crises.

Though the three central banks are moving in a similar direction, they are doing so for different reasons. For the Fed and the ECB, solid economic growth is helping convince officials to reconsider how much monetary juice their economies need, even though inflation remains puzzlingly low.

The BOE faces the opposite problem: Britain's decision to exit from the European Union last year is weighing on the economy in complex ways, including fueling an inflationary surge.

The BOE said Thursday after its latest policy meeting that it is leaving its benchmark interest rate steady at 0.25%, but the rate-setting Monetary Policy Committee said a majority of officials on the nine-member panel believe borrowing costs will need to rise soon to bring annual inflation back to its 2% goal. Annual inflation hit 2.9% in August.

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Such a move, which would mark the first interest-rate increase in the U.K. in almost a decade, is likely "over the coming months," the panel said, if the economy performs broadly in line with officials' expectations.

Sterling rallied 1.43% against the dollar and 1.17% against the euro, trading at $1.3399 and EUR1.1245 recently. U.K. 10-year gilt yields jumped too, rising to 1.18% shortly after the announcement from around 1.13% before.

Those movements suggest traders and investors were surprised by the BOE's statement, and now think a cut is a much more likely prospect in the near future. Paul Hollingsworth, an analyst at Capital Economics, said he thinks the BOE could act as soon as November.

In the U.S., the Labor Department said Thursday that consumer prices rebounded in August. The report delivered evidence to support Fed officials' expectation that a slowdown in price pressures this spring would be temporary. Until August, inflation had been muted for five straight months, prompting doubts over whether the Fed would be able to raise rates a third time this year as had been expected.

The consumer-price index, measuring what Americans pay for everything from medicine to rent, grew 0.4% in August from a month earlier, the biggest jump since January.

The Fed next week is expected to announce the October start of a plan that will allow initially small amounts of Treasury and mortgage bonds that it holds to mature without any reinvestment. The central bank stopped adding to its bondholdings in 2014, but has reinvested the principal from maturing assets to maintain their level since then. Any decision on additional rate increases isn't expected until December.

In Europe, the 19-nation eurozone economy has grown more strongly than expected this year, shrugging off the uncertainty created by a series of elections in the Netherlands, France and Germany that threatened but failed to yield gains for anti-euro nationalists. The ECB's economists now believe the eurozone economy is on course for its best year since 2007, reducing the need for support from policy makers. Much as in the U.S., though, inflation has yet to show signs of a sustained rise toward the central bank's target, which is just under 2%.

The BOE's challenge is more acute. Growth in the U.K. has slowed, but inflation is accelerating, twin consequences of voters' decision last year to exit from the EU.

Though it has made gains since the start of the year, the British pound remains down some 13% against the currencies of its main trading partners compared with where it was before the Brexit referendum. Sterling's slide has fueled a surge in consumer prices in Britain's import-dependent economy.

Officials had believed the inflation gains would soon fade, allowing them to hold borrowing costs low to support a slowing economy. But in recent months, they have become increasingly concerned that subdued investment and feeble productivity growth are hurting the economy's capacity to produce goods and services without causing inflation.

BOE Gov. Mark Carney warned last month that this supply-side squeeze means interest rates may have to rise soon, and officials doubled down on that advice Thursday. They said growth in the U.K., though modest, has been slightly better than forecast, and that any remaining slack in the labor market that would normally keep a lid on inflationary pressure is diminishing more rapidly than they anticipated as recently as last month.

"In order to return inflation to that 2% target in a sustainable manner, there may need to be some adjustment of interest rates in coming months, " Mr. Carney said in a broadcast interview aired Thursday.

Minutes of officials' deliberations showed the panel voted 7-2 to hold its benchmark rate steady. The two dissenters, Ian McCafferty and Michael Saunders, pushed for an immediate rise in interest rates.

The BOE has a recent history of seeing its plans derailed by surprise developments, including last year's vote to leave the EU. In response to the pound's sharp fall in the wake of that decision, the BOE cut its key interest rate to a record low in August 2016, and restarted a paused program of bond purchases.

With the U.K.'s departure from the bloc scheduled to take place in 2019, economists doubt the BOE will raise its key interest rate sharply if it does move soon.

Nick Timiraos contributed to this article.

Write to Jason Douglas at jason.douglas@wsj.com and Paul Hannon at paul.hannon@wsj.com

(END) Dow Jones Newswires

September 14, 2017 15:17 ET (19:17 GMT)