Bank of England holds rates as expected, ups growth forecasts for 2017

MPC’s tolerance for above target inflation is limited: BOE’s Carney

The Bank of England (BOE) raised its near term growth forecast for the second successive meeting on Thursday, while keeping its benchmark rates on hold.

The bank voted unanimously in its February meeting to keep interest rates at the record low level of 0.25 percent and keep its quantitative easing (QE) purchase targets at up to £10 billion ($12.6 billion) for corporate bonds and £435 billion for U.K. government bonds.

In its quarterly inflation report, the U.K.'s central bank cited the sizeable impact of the fiscal stimulus announced by Finance Minister Phillip Hammond at his latest budget statement as reason to be optimistic over Britain's economic health. The BOE forecast growth in the U.K. to hit 2 percent in 2017, upwardly revised from its November estimate of 1.4 percent.

Buoyancy since Brexit vote

Dylan Martinez | Reuters

The bank decided Thursday to maintain its inflation forecast for 2017 at 2.7 percent. The BOE sees inflation peaking at this level before edging slightly lower to 2.6 percent in 2018 and 2.4 percent by the end of 2019.

Gilt yields edged lower after the announcement with rate-setters supposedly sanguine about rising inflation. The pound moved sharply lower against the dollar, falling close to 1.260 after trading near 1.266.

Talking to reporters shortly after the release of the central banks quarterly inflation report, Governor Mark Carney was asked whether a rate hike or a rate cut would be the more likely course of action moving forwards.

"We can see scenarios in either direction," he quipped.

"This stronger (growth) projection doesn't mean the referendum is without consequence," Carney added.

In lifting its gross domestic product (GDP) forecasts for the current calendar year and next, the bank underlined the importance of the fiscal stimulus package put forward following the U.K.'s vote to leave the European Union, as well as robust economic strength in the U.S. and Europe as catalysts for Britain.

The unemployment rate in the U.K. is projected to rise slightly to 5 percent in the near term as labor demand softens, according to the BOE's February meeting minutes. This forecast is significantly lower than the 5.5 percent estimate made in November.

The BOE has acknowledged the economy's somewhat surprising buoyancy since the Brexit vote which has significantly exceeded its own expectations. However, the central bank has deferred the impact of Britain's withdrawal from the EU rather than omitted its effect altogether.

Before the Brexit referendum, the BOE's decisions and, perhaps especially, Governor Mark Carney's comments on the economic impact of an exit from the EU had been controversial. Carney has since dismissed any suggestion the central bank has a strained relationship with the U.K. government since the Brexit vote.

Slowdown as Brexit looms

Uncertainty is weighing on business investment: BOE Governor

While the bank's GDP forecasts were revised from November to show an overall increase of around 1 percent to the U.K.'s economy over the next three years, the BOE also projected a slowdown is on the horizon as Brexit looms.

The central bank cited volatility in the currency exchange rate, higher import prices and a bleak outlook for real post-tax household income as potential headwinds for the U.K. economy.

According to the minutes, "continued moderation in pay growth and higher import prices following sterling's depreciation are likely to mean materially weaker household real income growth over the coming years."

The value of sterling remains 18 percent below its peak in November 2015, which the central bank suggested was reflective of investor expectations' that a lower exchange rate would be required following the U.K.'s exit from the EU.

The U.K. Prime Minister Theresa May's plan to take Britain out of the EU cleared its first legislative hurdle on Wednesday.

Parliament voted overwhelmingly in favor of starting the formal negotiation process, boosting the prospect of divorce talks beginning with the bloc before her self imposed April deadline. Britain could complete the legislative process by March 7.

Carney was challenged in the press conference on whether it was wise to assume the central banks forecasts would stand the test of time as Brexit negotiations have not started yet.

He argued that given the vast range of possibilities for the U.K. and the EU throughout the negotiation process, "it would be false for us to try and narrow that gap before negotiations begin".

Since November, sterling has pared some of its losses to gain 3 percent against the dollar, and the BOE argued in its latest meeting minutes that given the currency strength, combined with a "somewhat higher yield curve over the past three months", the projected path of inflation rates remain relatively unchanged in comparison to its November forecast.