The Bank of England (BoE) announced that it could raise interest rates from the current record lows in little more than a year. The Bank of England slashed interest rates to 0.5 percent in 2009, during the international economic crash. As the economy continues to quickly recover, the bank considers various options.
On Wednesday, Bank of England Governor Mark Carney announced the intent to reintroduce pre-2009 rates, but only gradually. He stated that the bank would work to ensure that increases would mirror the steady economic recovery, so as not to overburden people and businesses whose comebacks are still precarious. Bank authorities hinted at an unofficial goal of a sustainable two percent interest rate within three years. The rate would be comparable to intended inflation rate, and enjoys support from economists, according to a recent poll.
Meanwhile, the pound jumped on Wednesday, suggesting that financial markets were factoring in an interest rate increase in 2015. Economist Brian Hilliard suggested that a benefit of the currency’s increase would be that it helps counter inflation.
While the bank promises to work with people in making financially recovery, it will not necessarily wait for unemployment to drop to seven percent, as previously stated. According to The New York Times, stimulus endeavors by the British government have helped to push the unemployment levels down significantly to 7.1 percent. Apparently, low-interest rates may not be as necessary at this point.
The Bank of England will focus on 18 separate measures of the “spare capacity” in Britain’s economy. When considering the economy, Spare capacity refers to ability to increase production from the current levels to an optimal level, without disproportionately increasing costs. Productivity and wages are key elements to the country’s spare capacity. Carney and his team appear willing to look at all aspects of this before deciding when to raise interest rates. Carney suggested that the BoE would study business surveys, the number of hours worked, and other material to gain the best insight.
According to experts however, it will be difficult to guess the BoE’s next maneuver. Peter Dixon, an economist at Commerzbank, criticized BoE for referencing a “nebulous concept” when mentioning spare capacity. He said that the bank needed to be more clear. Also, the BoE and other economists issued different estimates for growth in 2014. This too may be a subject of debate among financial experts as the situation progresses.
Despite the recent improvements in the British economy, concerns remain. There are some who believe vigorous reintroduction of interest rates would stifle a still vulnerable recovery. Higher interest rates drive the value of the pound, hindering exports. In addition, The New York Times reports that the UK is still under production capacity, and that the southeast of the country shows signs of a housing bubble.
Among the spectators watching closely to see what happens is Federal Reserve Chair Janet Yellen. As with the BoE, the Federal Reserve has said it would wait until unemployment rates are quite low before raising interest rates again. However, Yellen warned against obsessing over the unemployment rate. In nearly exact quote of her British counterparts, she suggested that analysts should look at a broad range of data on the labor market, including unemployment, and other aspects.
Yellen suggests that the Fed will wait to see what happens in the UK before making real decisions in Washington. If the Bank of England find enjoys success from raising interest rates, the no doubt the Fed will at least consider it. Not surprisingly, Washington and London seem committed to working together on this endeavor.
By Ian Erickson