Interest rates could take off early as policy makers change tone: Will 2015 see the first hike since 2007? 

Chris Papadopoullos
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Carney said the decision on when to move interest rates would be clearer at the end of the year

In April this year, Mark Carney became the first Bank of England governor to see deflation in Britain since Lord Cameron Fro­m­anteel Cobbold experienced a bout of falling prices in 1960.

But despite inflation undershooting its two per cent target by such a wide margin, Carney is preparing markets for a rate hike this year.
Markets are currently betting on rates coming off their record low of 0.5 per cent at around March next year. But now evidence is building that the Bank’s rate-setting committee will move sooner. Even market expectations have edged nearer February over the past two weeks.
Carney’s biggest hint came at a speech last week at an event marking the 800th anniversary of Magna Carta, where he said the decision on when to move interest rates would be clearer around the end of the year.
The pound rose half a cent in reaction to yesterday’s release of minutes of the most recent monetary policy committee (MPC) meeting – where rate setters vote on whether to hike, cut or hold interest rates.
The main event was a slight change in wording. In recent months, the minutes have been clear in saying the decision for two members was “finely balanced”. But in the latest release, the decision was such for “a number of members”.
This has been interpreted as meaning that three or four members are on the edge of voting for a rate hike.
“For these members, the uncertainty caused by recent developments in Greece was a very material factor in their decisions: absent that uncertainty, the decision between holding bank rate at its current level versus a small increase was becoming more finely balanced,” the minutes said.
That was then and this is now. Greece has agreed in principle to a new reforms deal to keep it in the Eurozone and stave off a default – for now – and is already steaming ahead with getting the preliminaries for a big new bailout plan out of the way.
With uncertainty surrounding the future health of the Eurozone coming down sharply, the scales could tip in favour of a rise for those on the MPC who are “finely balanced”.
Economists increasingly expect the committee’s unanimity to end at its meeting in August, with MPC members Martin Weale, Ian McCafferty and David Miles singled out as possible dissenters.
If they vote for a hike next month, only two more members will be needed. The current level of low inflation situation has not proved to be much of a deterrent to a rate hike preference.
This is because the MPC expects inflation to rise very quickly towards the end of the year for several reasons. The effect of the sharp drop in oil prices over the past year is expected only to be temporary. This was the Bank’s narrative in February.
The pound has also strengthened relative to many currencies, especially the euro. This has made imports cheaper for businesses that can pass on savings to shoppers, another effect which is expected to wear off. However, inflation was below target before these began to take effect. The final piece of the puzzle, from a rate-setter’s standpoint, is pay.
Pay growth hit its highest annual rate in five years in the three months to May – a sign that people and businesses are spending more, and that workers will spend more in future. Greater spending growth tends to eventually feed through to higher inflation.

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