Bank of England cuts growth outlook, backs market rate view

[LONDON] The Bank of England cut its forecasts for British economic growth over the next three years on Wednesday, and cautiously backed market expectations that it will only start to raise interest rates in around a year's time.

The central bank now expects growth this year to come in at 2.4 per cent, it said in its quarterly Inflation Report, down from a 2.9 per cent projection in February and closer to what most other economic forecasters expect.

Britain was the fastest growing of any major advanced economy last year, as it caught up on ground lost during the financial crisis.

But it slowed at the start of the year and Prime Minister David Cameron's newly elected Conservative government faces a major challenge to set the economy on a more sustainable path.

The BoE said its growth downgrade was due to interest rates being likely to increase faster than markets had expected three months ago, as well as a stronger currency and a weaker outlook for house building and productivity.

After saying in April that the pace of rate rises priced in by markets was unusually slow, policymakers now appear more happy with what markets have priced in since. "A path that implied only gradual rises in Bank Rate over the next few years, broadly in line with the current market path, remained consistent with absorbing slack and returning inflation to the target within two years," the BoE said.

The BoE's forecasts are based on market pricing for interest rates to rise from their record-low 0.5 per cent in the second quarter of next year - three months earlier than expected in February - and to average 0.9 percent in the last three months of 2016. The BoE has kept interest rates unchanged for more than six years.

However, policymakers said they were still concerned about the very limited increase in global interest rates priced in by bond markets in the longer term.

The days since the MPC's May 8 meeting have seen global bond yields increase sharply as investors respond to rising oil prices and the increasing likelihood of higher interest rates in the United States.

The BoE said that it expected British inflation, which currently stands at a record-low zero percent, to return to its 2 percent target in two years' time, little changed from its forecast three months ago.

But as well as cutting 2015's growth forecast, it also lowered projections for 2016 and 2017 to 2.6 per cent and 2.4 per cent respectively. "Growth is forecast to be at or a little below its historical average rate throughout the forecast period," the BoE said. Growth could be slower, due to increased risks of economic problems coming from Greece, it added.

The central bank also cut its forecast for wages, seeing them rising by 2.5 per cent at the end of this year compared with an earlier forecast of 3.5 per cent growth, before rising to 4 per cent next year.

REUTERS