The Bank of England joined other major central banks Thursday in signaling that a long era of easy money is gradually drawing to a close, saying that it anticipates raising interest rates in the U.K. at a faster pace than investors currently expect.
In its quarterly outlook, the U.K. central bank trimmed its growth forecasts for this year and next but said the economy's ability to expand without stoking inflation is being hamstrung by last year's vote to leave the European Union.
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BOE Gov. Mark Carney said the British economy is nearing its "speed limit" for growth as uncertainty about the future shape of the U.K.'s relationship with the EU causes businesses to put off investment or rethink expansion plans.
"The process of leaving the EU is beginning to affect potential supply in the U.K.," Mr. Carney said, adding that this squeeze means rate increases may soon be needed despite sluggish growth. Already inflation is above the BOE's 2% goal and Mr. Carney said officials expect it to accelerate further as a weakened pound works its way through the British economy. Unemployment is at a four-decade low.
Short-term interest rates in financial markets suggest investors expect the BOE to lift its benchmark rate only twice in the next three years, to 0.5% late next year and to 0.75% in mid-2020. But Mr. Carney said borrowing costs will need to rise more swiftly to keep inflation in check -- assuming the U.K. stays on course to negotiate a smooth transition from EU membership to a new trading relationship with the EU after Brexit, scheduled for March 2019.
The reaction in financial markets, though, suggests investors are doubtful the BOE will follow through. Officials voted six to two to hold their benchmark interest rate steady in August at 0.25%, a record low. Sterling fell 0.8% to $1.3119, while U.K. government bond yields, which move inversely to prices, fell. Economists said that the fall in sterling may also have reflected scotched expectations that a third official, possibly chief economist Andrew Haldane, was readying to join the minority advocating a rate rise.
The signal from London comes as accelerating growth in the 19-nation eurozone cements expectations that the European Central Bank will begin to phase out its stimulus measures next year as the region emerges from the shadow of the past decade's financial crisis.
In the U.S., the Federal Reserve r emains on course to raise short-term borrowing costs later this year despite some nerves over subdued inflation. Officials are also due to discuss shrinking the central bank's holdings of more than $4 trillion in bonds at their next meeting in September.
The U.K. central bank has been grappling with rising prices at the same time as stalling growth. A steep decline in the pound in the wake of last year's Brexit vote propelled prices sharply higher, squeezing household budgets and restraining consumer spending. The economy grew at an annualized rate of just 1.2% in the second quarter.
The BOE said it expects this "sluggish" growth to improve this year, with exports playing a greater role in driving growth against a strengthening global backdrop. It nevertheless cut its full-year growth forecast to 1.7% from 1.9% in May, reflecting the soft start to the year. It also cut its forecast for growth in 2018, to 1.6% from 1.7%.
Mr. Carney declined Thursday to be more specific on the timing or number of rate rises expected, saying he didn't want to tie officials' hands at coming policy decisions. Some economists expect the first rate increase to come as soon as November, though many see February as a more likely opportunity.
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(END) Dow Jones Newswires
August 03, 2017 13:16 ET (17:16 GMT)