MPC 'will take whatever action is needed'
Bank may cut interest rate as inflation falls towards zero, says governor
Governor Mark Carney today reiterated his belief that inflation will fall to zero, and may turn negative, though he insisted this did not mean the economy was following the eurozone into a period of deflation.
Inflation and the basic rate of interest are matched at 0.5% but the former is expected to fall in the spring which will mean the Bank missing its 2% target by a wide margin. It is also missing the 1% forecast made in November.
Mr Carney, delivering the Bank’s latest Inflation Report, warned that a weakening in global activity would put Britain at risk of falling prices which may require a cut in the headline interest rate. It will mark five years at the current record low next month.
In a letter the the Chancellor explaining the situation, Mr Carney said: “The MPC stands ready to take whatever action is needed, as events unfold, to ensure inflation remains likely to return to target in a timely fashion.”
The quarterly Inflation Report was generally positive about the British economy as low oil prices encouraged more activity. The Bank kept its growth forecasts unchanged at 2.9% for this year and next. Wages are expected to grow by 3.5% this year after rising by 1.75% in 2014.
Analysts’ comments and other reaction:
Nick Dixon, investment director at Aegon UK, said: ‘The Bank of England may not be showing much concern over stalling inflation, as low food and oil prices are generally considered to be supportive of economic growth, but there seems to be grounds enough for the dovish members of the central bank to be even looking at an interest rate cut.
“The threat of deflation, together with sterling’s gains against the euro, have created an unexpected challenge for the BoE, and we could see a 0.25% interest rate, and even a re-injection of quantitative easing, before the year is through.”
Gautam Batra, investment strategist at Signia Wealth, said: “Today’s report may warn of deflation coming over the horizon, but as a symptom of low oil prices, the impact will be transitory.
“All indications from the Bank of England suggest a lift off in interest rates from a shorter runway than the market currently expects. Rising wages and lower unemployment point to a resilient economy, and by downplaying risks from general elections and Europe, it seems monetary tightening may come sooner rather than later.”
Rain Newton-Smith, CBI Director of Economics, said: “While the risk of deflation is growing, it is unlikely that we will see falling prices for a prolonged period, as the pressure from lower oil prices unwinds ahead.
“Falling oil prices have knock-on benefits to the wider economy for companies and households, but the North Sea oil industry is being hit hard. As an immediate step, the Government should announce a commitment to reduce the supplementary charge in the Budget.
“With the Monetary Policy Committee alert to the risk of low inflation becoming entrenched, a rise in interest rates anytime soon seems off the cards.”
Ian Kernohan, the Chief Economist at Royal London Asset Management, believes that today’s Inflation Report, highlighting declining inflation, is predominantly the result of falling oil prices and will be shortlived. Also, the headline inflation rate could rise rapidly when the effect of the oil price fall drops out of the year-on-year comparison.
“The Bank of England pushed back on market expectations that interest rates will remain on hold until late 2016. Although inflation will fall further and probably into negative territory, the primary reason for this is the sharp fall in the oil price and the lagged impact of stronger sterling, rather than widespread declines across the inflation basket.
“Cheaper energy is actually a reflationary impulse further out, and once the oil price effect drops out of the year on year comparison, the headline rate of inflation should rise quite rapidly, albeit from a very low level. The Bank feels that slack in the economy has continued to fall and now accounts for just 0.5% of GDP. Of course there are risks and interestingly the Bank has now opened up the possibility of Bank Rate falling below 0.5%, should prospects for the economy deteriorate.”