Britain has suddenly moved to the front row of developed economies looking to lift interest rates. Its behind New Zealand where the country’s central bank lifted rates a third time on Thursday to a five year high, but Britain, piloted by the newish jockey in Bank of England Governor, Mark Carney made a swift dive through on the rails on Thursday night to be just behind the Kiwis.
Carney’s blunt warning in a speech in London startled markets and sent the pound soaring.
“There’s already great speculation about the exact timing of the first rate hike, and this decision is becoming more balanced. It could happen sooner than markets currently expect,” he told the annual Mansion House dinner in London early today, our time.
Driving the changed thinking about the health of the UK economy, Mr Carney said "economic currents are flowing swiftly, with the economy expanding at an annualised rate of 4% and jobs growing at a record pace. But there are rapids ahead, with old imbalances persisting and new ones emerging. The economy is still over-levered. The housing market is showing the potential to overheat. And the current account deficit is now at a record level."
He stressed that the widely anticipated action by the central bank this month to cool the booming UK housing sector (especially in London) will not be a substitute for gradual interest rate rises.
“Growth has been much stronger, and unemployment has fallen much faster than either we or anyone else expected at last year’s Mansion House dinner,” Carney said (which he spoke at for the first time as the Bank of England Governor).
"The ultimate decision will be data-driven. At this point it is safest to conclude, as the MPC has, that there remains scope for spare capacity to be used up before policy is tightened and that a host of labour market, capacity utilisation and pricing indicators should be watched closely to determine how that slack is evolving. So far this has been largely matched by indicators which suggest that there is more supply capacity in the labour market than we had previously thought," Mr Carney said.
At that speech last year Mr Carney guided people to expect rates to remain at the emergency level of 0.5% until 2016. Since then the UK economy has staged a solid recovery, with growth expanding faster than thought and employment soaring. House prices though have surged, especially in London leading to growing fears a bubble was developing.
Up to his speech last night the first rate rise from the central bank was expected in 2015, in the northern spring (May?). Now the timing is settling on late this year.
“So far this has been largely matched by indicators which suggest that there is more supply capacity in the labor market than we had previously thought. As a result of these two welcome developments, despite rapid jobs growth, pay pressures and unit labor cost growth have remained subdued.”
An increase won’t endear himself or the central bank to the Conservative government which faces a general election next May.
While George Osborne, the UK chancellor, has said this year that a rate rise would demonstrate the strength of the recovery, it could bolster also increase pressure on the government from voters made nervous about the charge of the opposition Labour party that there is a “cost of living” crisis in the countdown to the election.
But a rate would be more symbolic – an official rate of 0.75% still represents a very accommodative stance for monetary policy in the UK.
In his speech, Mr Carney repeatedly stressed the BoE would act cautiously once it started to raise rates because “the effects of an excessive or an excessively rapid tightening of monetary policy could prove damaging and difficult to undo”.
“The need for internal balance – to use up wasteful spare capacity while achieving the inflation target – will likely require gradual and limited interest rate increases as the expansion progresses. The start of that journey is coming nearer,” he said.
On the booming housing sector, Mr Carney made it clear the bank was increasingly unhappy with what it was seeing in the market.
The Financial Times commented that the speech "showed the BoE has become uncomfortable with market expectations that it would seek to use macroprudential tools such as limits on mortgage lending to cool the housing market while letting the rest of the economy continue to boom."
"Saying there were the “early signs” of a housing bubble in the property market, he warned that there were also some signs that mortgage lenders were allowing households to overextend themselves and said the new Financial Policy Committee had the tools to deal with this specific problem.
“We are not up the proverbial creek without a paddle,” he said hinting the BoE would act early to insure the recovery against a more dangerous credit-fuelled housing bubble."
This is far more direct language than what we have heard in Australia from APRA and the Reserve Bank who have been more guarded in their comments.
And yet both our regulators feel the same way, hence the announcement last month of new guidelines for banks and other home lenders, especially to boards, about some forms of home lending, such as loans with high Loan to Valuation ratios, non-interest loans and loans to self managed super funds.
