BOE sees strong growth but ready to cut rates if needed

London

THE Bank of England (BOE) said that it expects stronger growth on the back of lower oil prices but it sees little need to raise interest rates this year and could even cut them if inflation proves weaker than expected, new forecasts showed on Thursday.

BOE governor Mark Carney said that he expected inflation to fall below zero in the coming months due to weak oil, but stressed that this by itself did not mean that the economy had entered deflation.

Inflation would hit the BOE's 2 per cent target in about two years' time, it said, sooner than it forecast three months ago.

In its analysis, the BOE lowered its 2015 inflation forecast to 0.5 per cent from 1.4 per cent. For next year, it sees inflation accelerating to 1.8 per cent, then to 2.1 per cent in 2017.

In a letter to Chancellor of the Exchequer George Osborne, published alongside the report, Mr Carney said that he does not want to wait too long before trying to get inflation back to its goal, and will aim to reach the goal once the impact of the oil price slump abates.

"Given the nature of the shocks affecting inflation, the MPC (Monetary Policy Committee) judges it appropriate to set policy so that it is likely that inflation will return to the 2 per cent target within two years," Mr Carney wrote. The letter was triggered by inflation falling more than one percentage point from target.

"The UK is not experiencing 'deflation'," Mr Carney said in the letter explaining the difference between inflation - which stood at 0.5 per cent in its most recent reading - and the Bank's 2 per cent target.

However, if global activity weakened and Britain became at risk of a vicious cycle of falling prices, the BOE said that it was ready to cut rates, following in the footsteps of other central banks.

This is a major break from its previous position, where it had said that this would be of little benefit, and that some lenders were too weak to cope with rates below 0.5 per cent.

"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," Mr Carney said.

"(It is) appropriate to return inflation to target as quickly as possible after the effects of energy and food prices movements have abated," Mr Carney said in remarks following the release of the BOE's forecasts.

"Output growth remains solid and domestic demand growth robust," Mr Carney told reporters at a press conference in London. Officials will look through the effect of energy prices and "the most likely next move in monetary policy is an increase in interest rates".

The governor said that any increases will probably be limited and gradual, as the report noted risks to the economy, including from the euro area. He said that the MPC could lower the benchmark rate even further or restart asset purchases if downside inflation risks materialise, adding that banks are now better placed to withstand a rate cut without harming the supply of credit.

Sterling rose to a day's high against the US dollar and British government bond prices fell moderately after the quarterly Inflation Report, whose overall thrust was upbeat, with the economy close to being back to running at full capacity.

The central bank raised its growth forecasts and predicted that wages would grow faster, suggesting that voters may feel some of the benefit of the recent economic rebound before Britain goes to the polls in May.

Average consumer price inflation in the second quarter of this year is likely to fall to a record low annual rate of zero, the BOE forecast, lower than the one per cent that it forecast in November.

After that, the BOE forecasts that it will climb steadily to its 2 per cent target in two years if it raises interest rates as markets expect.

Financial markets did not expect the BOE to start to raise rates from their record low 0.5 per cent until the third quarter of 2016, the BOE said.

The fact that the BOE forecasts that inflation will marginally overshoot its target if interest rates do not rise until then suggests that it may want to raise interest rates slightly earlier. Since the BOE calculated its forecasts, markets have already priced in a somewhat earlier move in early 2016.

The BOE said that the drop in oil prices will boost real incomes, and help sustain "robust" domestic demand. It raised its forecast for growth in post-tax real incomes to 3.5 per cent this year from 1.25 per cent. REUTERS, BLOOMBERG