Markets react with disappointment to UK inflation report

Bank of EnglandThe latest inflation report by the Bank of England dashed hopes that the first benchmark rate hike in seven years would be brought forward to January next year.

Markets reacted with disappointment over the dovish inflation report, after which it became clear that the benchmark rate is likely to raise only in the first half of next year.

Mark Carney, the bank’s governor, left his growth and inflation forecasts broadly unchanged, and kept benchmark rates at a record low.

The Monetary Policy Committee says it expects inflation to return to target by 2016, making it increasingly likely that that the benchmark rate will increase modestly over the next few years to below pre-crisis levels.

Richard Nehme, dealing director, International Foreign Exchange, says markets had, perhaps over-ambitiously, been hoping for signs that the first rate hike in seven years could be brought forward to January.

“It has been a common theme for Bank of England governors in the past to use the occasional dovish commentary to weaken the pound, which is a preference for a recovering economy,” Nehme says.

“Some may question, with such a strong history of aiming to keep our currency down, why so many repeatedly fall into the same trap of disappointment.”

Despite the recent recovery, there are concerns over the health of the UK economy. Nehme says the recent 10% surge in the UK housing market is stoking concerns of a housing bubble while retail sales growth and consumer price inflation remain weak.

Nehme says that as long as these areas of the economy show some slack, it is understandable that Carney does not want to raise interest rates any earlier.

Sterling fell to a four-week low against the dollar on the news. Over the last year, it had jumped 13% as the UK economy bounced back. Nehme forecasts a “healthy” 3% growth rate this year.

Martin Beck, senior economic adviser to the EY Item Club, says that the committee was careful to emphasise that increasing signs of a boom in the housing market need not impact on interest rate policy.

“So with prospects for inflation looking very benign and the Monetary Policy Committee seemingly confident that macro-prudential tools will serve their purpose, we are sticking to our view that a rise in Bank Rate will not happen until well into 2015,” Beck adds.  

Peter O'Flanagan, head of trading at Clear Currency, adds that the euro has carried its own troubles from this month’s European Central Bank meeting.

“All week we have warned that markets were essentially pricing in perfection for the UK economy and their interest rate outlook, which left [Sterling] vulnerable to selling,” O’Flanagan says, adding that this has happened as the inflation report was more subdued than many were looking for.

He says: “The problem is that markets wanted Mark Carney to put a date on a rate increase, what he did was emphasise that the Bank of England would not raise interest rates to tackle concerns of a housing bubble, instead other measures would be introduced.”

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