Credence Independent Advisors: Why interest rates won’t rise anytime soon?

Economists expect Bank of England’s quarterly health check of the UK economy to rubber stamp expectations that interest rates will remain low for longer.

Interest rates will remain on hold beyond next year’s general election; the Bank of England is expected to signal this week, in an environment of lower inflation, weak wage growth and increasing eurozone headwinds.

Economists expect the Bank’s latest Inflation Report to highlight a risk that price rises, as measured by the consumer prices index (CPI) could fall below 1pc at the beginning of 2015, from September’s five-year low of 1.2pc.

According to the Centre for Economics and Business Research (CEBR), the recent decline in oil prices to $83 a barrel from $115 in June will push CPI inflation down to 0.5pc by next June. Douglas McWilliams, chief executive of the CEBR, said if prices fell to $60 a barrel, headline inflation could turn negative.

If inflation dips below 1pc, Mark Carney, the Governor of the Bank of England, will have to write an open letter to the Chancellor explaining the fall and how policymakers will ensure that inflation returns to the Bank’s 2pc target.

Alan Clarke, a strategist at Scotiabank, said it was very likely this could happen before the end of this year. “Last December, we had a 6.5pc increase in gas and electricity prices, that’s not being repeated this year, so that will push inflation down by 0.3 percentage points.

Coupled with that you’ve got Sainsbury’s recent decision to cut 1,200 prices and mild autumn weather pushing down on clothing prices. All in all, if they forecast sub-1pc inflation they’re conceding that Carney’s going to have to write a letter and the market will push back the first hike even more than it already has done.”

In June, Mr. Carney said the decision surrounding the timing of the first rate increase “could happen sooner than markets expect”, prompting traders to price in a November rate hike. However, an oil glut, the slowdown in the eurozone and falling inflation means markets now expect the Bank to raise rates in August 2015, well after May’s election.

Andrew Haldane, the Bank of England’s chief economist, said in a speech last month that a “gloomier” global outlook and lower inflation suggested that policymakers could afford to keep interest rates lower for longer.

Official data show pay growth still catching up with price rises

The Deputy Governor, Sir Jon Cunliffe, said in a separate speech that with interest rates already at a record low of 0.5pc, dealing with an inflation spike would be “more manageable” than raising rates too early and having to change course.

However, Martin Weale, an external rate setter who has voted to tighten monetary policy for the past three months, has argued that the Bank should “look through” the current drop in inflation because it is driven by forces that are beyond the Bank’s control, as the Monetary Policy Committee did in 2008, when price rises spiked to 5.2pc.

Simon Wells, chief UK economist at HSBC and a former Bank economist, said pay growth would remain in focus for the nine rate-setters. “The first quarter of 2015 is an important time for pay settlements, and if pay surveys continue to suggest starting salaries for new recruits and vacancies are rising and we start to see wages pick up, that would be the signal for me that this economy can withstand a rate rise”.

The Confederation of Business Industry expects the UK economy to expand this year at the fastest pace since before the financial crisis. Britain’s biggest business lobby group expects growth of 3pc in 2014, which would match the expansion in 2006. Growth is then expected to slow to 2.5pc in 2015.

The forecasts were unchanged from its September forecasts, despite renewed fears of a triple dip recession in the eurozone. “The recovery is on firm ground and is becoming more ingrained,” said John Cridland, the CBI’s director general.

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