(London) The Bank of England delivers its latest forecasts for the UK economy today, with any marked improvement likely to be seen as a signal that interest rates may increase earlier than expected. Experts have pencilled in a hike in the cost of borrowing from its historic low of 0.5% for the spring of next year.
But the City is likely to bring forward its expectations of a rate rise if the Bank’s quarterly inflation report signals a belief that key economic indicators are showing accelerating improvement.
It could lift the prospect of a rise before 2015’s general election or even this year.
City expectations about when the Bank rate will rise are important, because they affect rates currently offered on the market, feeding into mortgage and other loan deals.
The Bank’s latest forecast for gross domestic product (GDP) growth for 2014 is 3.4%, but it recently increased its prediction for first quarter expansion, leading to speculation that the rise for the year will also be revised up.
Official figures for growth in the first quarter of this year came in lower than the Bank expected.
But subsequent surveys of business performance suggested the private sector was adding about 100,000 jobs a month, while manufacturers’ confidence was the highest since the 1970s.
Another key indicator – known as spare capacity, or “slack” – in the economy, could also prove significant.
This measure has been placed at the heart of the Monetary Policy Committee’s (MPC) thinking after it abandoned “forward guidance” explicitly linking interest rates to the unemployment rate.
Policy makers have pointed to making further progress towards eliminating this before the next rate rise. In February’s inflation report, the spare capacity gap was estimated at 1-1.5%.
Societe General economist Brian Hilliard said: “If the estimate is lowered by any significant amount then the markets will interpret that as a signal of imminent rate action.”
Members of the MPC have aired differing views about the current level of slack.
It is a more opaque measure than the unemployment rate. Official figures on the same day as the inflation report are expected to show the latter falling to 6.8% – well ahead of the Bank’s predictions last year.
Interest rates have been on hold at 0.5% for more than five years to try to nurse the economy back to health. They have remained there even as the recovery has gathered pace, as policy makers look for signs of a more sustained economic upturn.
Low inflation has removed the pressure for interest rates to have to come up sooner but signs of accelerating growth would stoke fears of inflationary pressures to come.
Surging house prices are unlikely to have any direct effect on interest rates for the time being as the Bank of England has said it would rather use other tools at its disposal to cool a potential property bubble before having to raise rates to do so.