BOE Says Interest Rates Could Rise Within Months -- 2nd Update

The Bank of England signaled Thursday that officials are preparing to raise interest rates within months to restrain accelerating inflation, a fresh sign that a decadelong era of ultraloose central-bank policy is slowly drawing to a close.

The BOE held its benchmark interest rate steady at 0.25% following its September policy meeting but the rate-setting Monetary Policy Committee said in a statement that a majority of officials on the nine-member panel believe borrowing costs will soon need to rise to bring annual inflation back to its 2% goal.

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 0.9% against both the dollar and the euro to $1.33 and EUR1.12 respectively.

U.K. 10-year gilt yields jumped too, rising from around 1.13% before the announcement to 1.18% shortly afterward.

Those movements suggest traders and investors were surprised by the BOE's statement, and now think a first rise in the key rate since 2007 is a much more likely prospect in the near future.

"The first hike could come somewhat earlier than we had previously envisaged, possibly as soon as the next meeting in November alongside the Inflation Report," said Paul Hollingsworth, an analyst at Capital Economics, referring to the next set of economic and growth forecasts due from the central bank.

The BOE's step toward tighter monetary policy comes as the Federal Reserve is gently increasing short-term interest rates in the U.S. and the European Central Bank ponders when to round off its multi-trillion euro asset-purchase program amid a buoyant eurozone economy.

The U.K. central bank faces a unique challenge: Britain's decision to exit the European Union in June last year is having multiple effects on its economy that are complicating officials' policy-setting task.

Though it has made gains since the start of the year, the British pound remains some 13% down against the currencies of its main trading partners than it was before the Brexit referendum.

Sterling's slide has fueled a surge in consumer prices in Britain's import-dependent economy; annual inflation hit 2.9% in August, well in excess of the BOE's 2% target.

Officials had believed the boost 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 is hurting the economy's capacity to produce goods and services without causing inflation.

BOE Governor Mark Carney warned last month that this supply-side squeeze means interest rates may have to rise sooner than investors then expected. At the time, investors doubted the BOE would raise interest rates this year or next.

Significantly, officials repeated that warning Thursday -- even though market expectations for a rate increase have advanced to around the middle of 2018.

Officials 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.

Minutes of officials' deliberations showed the panel was split seven to two on holding its benchmark rate steady. The two dissenters, Ian McCafferty and Michael Saunders, pushed for an immediate rise in interest rates.

While the BOE appears to be closer to a rate rise than previously thought, the central bank 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, and some believe it will limit itself to a reversal of the 2016 rate cut.

"Economic uncertainty relating to Brexit and the risks this poses for activity means that such action would not be the start of a new tightening cycle," said James Knightley, an economist at ING Bank.

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

(END) Dow Jones Newswires

September 14, 2017 08:16 ET (12:16 GMT)