LONDON (Reuters) - The Bank of England sees British inflation falling below 1 percent in the next six months and Governor Mark Carney said markets were right to rule out an interest rate hike any time soon.
The BoE predicted a very slow rise in inflation over the next three years and noted how markets were expecting rates to remain at their record low for almost another year.
“It is appropriate that, while a tightening in monetary policy remains in prospect, markets now expect somewhat easier monetary conditions over the forecast period than was the case three months ago,” Carney told a news conference after the Bank released its quarterly Inflation Report on Wednesday.
Sterling weakened and British government bonds prices rose on the bank’s comments.
Carney said it was “more likely than not” that he would soon have to explain a fall of inflation to below 1 percent to finance minister George Osborne.
He also pointed to “troubling” developments in the euro zone, home to Britain’s main trading partners, where the economy is at risk of falling back into recession.
Britain’s economy has grown unexpectedly strongly over the past year, leaving economists uncertain whether the BoE or the U.S. Federal Reserve will be first to raise rates. The European Central Bank, by contrast, is mulling more stimulus.
The prospect of British interest rates remaining at 0.5 percent — their level for nearly six years — until the second half of next year will be welcome news for Prime Minister David Cameron who is facing a national election in May 2015.
Economic data released on Wednesday showing a stronger-than-expected increase in earnings, albeit from weak levels, was further good news for the government.
As recently as June, Carney had been warning that markets had overlooked the chance of an early rate rise.
Carney stressed on Wednesday that the views of investors “shouldn’t be taken as validating any particular date for the first rate increase” and he sought to play down suggestions from reporters that he was determined to keep interest rates low.
“I’m still the only G7 governor who has raised interest rates. I just haven’t happened to have done it here,” Carney said, referring to the Bank of Canada’s decision, under his leadership, to raise borrowing costs in 2010.
“But I also know what it is to hit an inflation target, which is what the MPC (Monetary Policy Committee) is striving to do,” he said.
Inflation has fallen unexpectedly fast to a five-year low of 1.2 percent, and the BoE said the outlook for inflation had also weakened due to a sharp fall in commodity prices.
If it raised interest rates as markets expected, inflation was still likely to be just below its 2 percent target in two years’ time and would only hit it at the end of 2017, it said.
Despite a weaker global outlook, the BoE left its forecasts for British economic growth little changed, saying that cheaper finance should offset the effect of weaker overseas demand.
It continues to expect 3.5 percent growth this year, making Britain the world’s fastest-growing, big rich economy, followed by 2.9 percent in 2016, a shade lower than its August forecast.
The weakness in the euro zone posed the biggest risk to Britain’s recovery and could upset financial markets, it said.
The BoE also still sees a big rebound in wage growth next year, with wages rising by 3.25 percent — a rate not seen since the financial crisis — after growth of 1.25 percent this year.
After a rapid fall in unemployment over the past year, the BoE expects more modest declines ahead, with the rate down to 5.4 percent by late 2015 from 6 percent now.
Additional reporting by London bureau; Editing by Hugh Lawson and Susan Fenton