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BoE upgrades growth forecasts as recovery takes hold

The Bank of England (BoE) updated its growth, inflation and unemployment forecasts Wednesday, raising market expectations that it could raise interest rates sooner than expected -- but not just yet.

The bank updated its inflation, growth and unemployment rate forecasts on Wednesday to reflect an increasingly rosy picture of accelerating growth, falling inflation and a four-year low in unemployment in the U.K.

Economists and analysts had widely expected the report, published on Wednesday morning, to show a shift in the Bank's outlook following better-than-expected data, and there had been concerns that the revisions could mean that it hikes historically low interest rates sooner than expected.

(Read more: Will BoE inflation report signal early rate hike?)

In its latest quarterly Inflation Report, the bank predicted that the U.K. could see 7 percent unemployment as early as the last quarter of 2014, if interest rates stay low, two years earlier than it had expected in August.

However, it believed the unemployment rate was more likely to hit 7 percent at the end of 2015 or end of 2016, giving such predictions a 57 percent and 68 percent probability respectively based on market interest rates.

The Bank of England's Governor Mark Carney was keen to stress that hitting the unemployment target, however, would not necessarily trigger a rate rise.

"For the first time in a long time you don't have to be an optimist to see the glass is half full," Carney told a press conference. "The recovery has finally taken hold."

The central bank also raised its growth forecasts, seeing gross domestic product (GDP) expanding in 2013 by 1.6 percent, up from a previous forecast of 1.4 percent, made in August. It sees the economy expanding by 2.8 percent in 2014.

He warned however that a return to growth is not yet a return to normality and that inflation may tick up slightly in coming months if recently announced utility prices take effect. "Quarterly growth rates of GDP are likely to ease back a little next year, and over the forecast horizon growth is likely to remain modest compared to past recoveries," he said.

Carney insisted that households and businesses need not be concerned over an imminent hike in interest rates, which would have the effect of damping spending and investment.

"It's all about the conditions in the economy - that's what will determine a change in interest rates," he told reporters. "We're not going to even consider raising interest rates until that 7 percent rate unemployment rate is reached. Only once it's reached will we then look at the slack and momentum in the economy and then we'll take the decision."

He also did not rule out lowering the unemployment threshold should the 7 percent target be reached faster than expected.

The pound rose against the dollar, to $1.598 from $1.590 at the start of trading, following the release of the report but has since fallen to $1.5966. In addition, 10-year U.K. Gilt yields also rose to a high of 2.85 percent but fell back during Carney's press conference as he tried to assure markets of continued low rates for some time to come. They are currently at 2.83 percent.

The Bank of England's revisions were expected by analysts, coming against a backdrop of accelerating growth, falling inflation and a four-year low in unemployment in the U.K.

On Wednesday, new figures showed the U.K.'s unemployment rate fell to 7.6 percent between July and September, down from 7.8 percent in the previous quarter, the Office for National Statistics (ONS) said. That was in line with forecasts and means the rate is at its lowest point since the three months to April 2009.

(Read more: UK economy should beware 'weapons of mass distraction')

On Tuesday, meanwhile, official figures showed that the cost of living for Britons had fallen to its lowest level for more than a year. Inflation fell to 2.2 percent in October from 2.7 percent in September, significantly below the 2.9 percent rate previously forecast by the BoE for the fourth quarter, the ONS reported.

Economists appeared to buy into Carney's reassurances of a delayed rate hike. They told CNBC the bank would be very cautious in changing its forward guidance and increasing interest rates before the U.K.'s economy showed a sustained recovery.

"The latest Inflation Report confirms that good news comes in threes, with the outlook for jobs, output and inflation all improving at the same time," KPMG Chief Economist, Andrew Smith, said following the report.

"Although even optimists have been surprised by how strong 2013 has been, the recovery is not yet secured and a number of headwinds could still knock it off-course. And for all the excitement, almost six years on output is still below its previous peak...and the Bank has ruled out an early rate rise or reversal of quantitative easing."

Karen Ward, senior global economist at HSBC told CNBC the change in the bank's outlook came as little surprise: "I think they've acknowledged the data we've seen. They had to admit that the data has certainly come through much stronger than they had expected."

She warned against "getting too carried away" with the data however, as real wage growth remained "extremely squeezed" which would weigh on consumption and growth. "It's very hard to see such strong data continuing when this real wage squeeze is such a problem for the U.K. economy and the consumer."

Meanwhile, Chris Williamson, chief economist at Markit commented that "recent data and survey analysis of productivity also suggest that the amount of slack in the economy is also falling fast, adding to the sense that it might be appropriate for policy to be tightened earlier than 2016."

But Michael McMahon, professor of Economics at the University of Warwick, told CNBC that the bank's forward guidance was "effectively a period of time to effectively say they're trying to understand what's going on in the economy" and not to radically change policy direction.

"There's a lot of uncertainty about [the economy] and what they've been really stressing today is that when we hit that 7 percent unemployment rate it's a trigger not to change interest rates, but a trigger to start thinking about changing interest rates. The hope is when they get there, they have a better idea what's going on," he added.

The general improvement in the economy appears to have increased expectations among the public that the bank will hike rates sooner rather than later.

British households believe interest rates could rise imminently, according to survey data collected by Ipsos MORI on behalf of research house Markit.

According to the survey published on Wednesday ahead of the BoE's report, out of 1,500 households surveyed, 72 percent of UK households expected the BoE to start raising interest rates within the next two years, up sharply from 55 percent in August. One-in-four expected a hike in the next six months, Markit said.

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