BOE holds rate at 0.5% as Carney prepares to signal outlook

London

MARK Carney may be getting ready to unsettle investors again.

The Bank of England (BOE) governor has an opportunity this week to address bets that he'll keep interest rates unchanged until mid-2016.

Market sentiment shifted on Friday after the Conservative election victory, with traders predicting the BOE will offset tight fiscal policy by holding borrowing costs at a record low for longer.

The bank maintained the benchmark at 0.5 per cent on Monday, as forecast in a Bloomberg survey.

The economy has grown for nine straight quarters and, while inflation is below the BOE's target, oil prices are rising. Against that backdrop, Mr Carney might stop short of endorsing the view that the key rate will stay unchanged for more than another year when he presents new forecasts on Wednesday.

His press conference on Wednesday is a chance for the governor to repeat what he's done before and tell investors they've gone too far.

"We wouldn't be surprised to see the BOE nudge up their inflation forecasts," said James Knightley, an economist at ING Bank in London who sees a "good chance" of a November rate increase. Policy makers may "emphasise a little more forcibly that the prospect of interest rate rises is getting closer".

The Tory victory, in stark contrast to opinion polls that had suggested no party would command a clear majority, clears Prime Minister David Cameron's path to continue cutting spending.

His planned fiscal squeeze is more aggressive than what the opposition Labour Party had proposed as he aims to eliminate a deficit of almost 5 per cent of gross domestic product (GDP).

The publication of the Inflation Report gives Mr Carney and other Monetary Policy Committee (MPC) members their first chance to speak publicly in more than a month after they went into purdah during the election campaign. The central message in remarks before the silent period was that the next most likely move in rates would be an increase. Since then, data showed GDP growth eased in the first three months of the year, though surveys indicate the economy is rebounding this quarter.

"Our hunch is that the market is a bit too relaxed about it all at the moment," said Victoria Clarke, an economist at Investec Securities in London. "The bank was warning in February about a risk of an inflation overshoot and we don't see that going away. The underlying trend is still for a recovery."

As the surprise election result sank in on Friday, investors pushed out their forecast for the first rate increase to the third quarter of next year, Sterling Overnight Interbank Average Rate (Sonia) forward contracts showed. They've since come back in to about June 2016, where they were before the ballot. In the minutes of its April meeting, the MPC had already noted markets were anticipating an "exceptionally slow" pace of tightening.

The decision was delayed from last Thursday because of the election. The MPC will publish minutes of this month's meeting on May 20. The pound was up 0.1 per cent at US$1.5471 as of 12:10pm London time. The yield on the 10-year gilt rose three basis points to 1.90 per cent.

With inflation at zero, the panel is under no immediate pressure to tighten. The BOE's forecasts in February showed consumer-price growth would reach the 2 per cent goal in 2017.

The recent bout of below-target inflation means Mr Carney will have to send an open letter to Chancellor of the Exchequer George Osborne explaining how he'll deal with it. The BOE will publish that alongside the Inflation Report.

The new projections will have to account for a 40 per cent increase in oil from a low in January and signs of recovery in the euro area, Britain's largest trading partner.

Data on Wednesday may show the 19-nation economy grew 0.4 per cent in the first quarter, the fastest in four years.

A majority of economists in a Bloomberg survey expect the BOE to leave its projections unchanged. It will also maintain its growth forecast even after the UK's expansion slowed to 0.3 per cent in the first quarter. BLOOMBERG