Mark Carney plays down imminent rate rise amid weak wage growth

Jesse Norman, the Conservative MP, added: “This seems to be potentially a return to good old-fashioned smoke and mirrors. If interest rates are supposed to be determined by data, then as soon as the data changes, the MPC’s view changes, you make a speech, and monetary policy changes. How can that be a sustainable way to set monetary policy?”

^{The pound dropped after Carney appeared to contradict himself Graph: Bloomberg}

Sterling fell by half a cent against the dollar on Tuesday morning to $1.6977 on the back of the Governor’s comments. Markets had interpreted his Mansion House speech as a signal that interest rates were likely to rise before the end of this year, and had priced-in an increase for 2014.

While Mr Carney admitted that the Bank’s unemployment forecasts had been “obviously wrong”, he insisted that the central message that any rate rises would be “limited and gradual” had remained consistent.

The Governor said his Mansion House speech was designed to quash speculation that rates were “never going to go up” or that they would return to the average of 5pc seen before the financial crisis. He added that his comments were also aimed at correcting the belief that there was only around a 15pc chance that interest rates could rise before the end of 2014. However, he repeated that the ultimate decision to raise rates would be driven by the performance of the economy.

In a robust defence of forward guidance, Mr Carney claimed that many businesses had hired new workers and made investment decisions based on the certainty that the policy had provided, adding that the timing of the first rate rise was less crucial than the pace of increases. “We do need and all want a durable recovery,” he said. “We don’t want business decisions and personal decisions taken today ... that are based on expectations of interest rates that are unlikely to transpire.

“One danger is that people assume, having lived through years of interest rates at their rock bottom level, that they’re never going to go up. We have to dispel that, and I think that’s understood. The other extreme is that people assume that they will go up to historic levels and at historic rates.”

Mr Carney said that while his Mansion House speech had triggered a change in expectations of the timing of the first rate rise, markets continued to believe that the pace of tightening would be “half the rate of previous tightening cycles in the UK”, while rates were expected to settle at around 2.5pc - or half the historic average. “With that speech, the one thing that didn’t change was either of those expectations,” said Mr Carney. “So 'limited and gradual’ has got through to the market.”

The Governor of the Bank of England told MPs yesterday that while the economy was showing no signs of slowing down from its annual growth rate of around 4pc, weak wage and productivity growth made the decision to begin raising interest rates from a record low of 0.5pc more balanced.

He highlighted that that there had only been a handful of months since 2008 where average weekly earnings had climbed above inflation. The Governor said this suggested there was more room for the economy to expand without pushing up prices. “The developments on the wage front suggest to me .... that there has been more spare capacity in the labour market than we previously had thought,” he said.

This sentiment was echoed by fellow MPC member David Miles, who suggested that the so-called “output gap” could be larger than the 1pc to 1.5pc estimate published by the Bank. “I think there is a significant amount of slack there,” he said. “I’m probably at the upper end of the range that we talk about - 1 to 1.5pc. I think it’s quite plausible that there may be more spare capacity.”

The Institute of Directors became the first business organistation to call for a rate rise this year, potentially as early as the autumn. “Ultra-loose policy successfully lessened the impact of the recession, but as the recovery takes hold it will soon be the time to start taking interest rates to a level where monetary policy can once again become an effective economic lever,” said James Sproule, the IoD’s chief economist.

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