Pound falls as Bank of England plays down rate rise

 

Pound Sterling v US Dollar

Last Updated at 27 Nov 2014, 16:10 ET *Chart shows local time GBP:USD intraday chart
£1 buys change %
1.5738 -
-0.01
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-0.35

The pound has fallen sharply after the Bank of England warned that markets were wrong to assume that it would start raising interest rates soon.

Sterling immediately dropped a cent and a half against the dollar to $1.5141.

It came as the Bank held interest rates at 0.5% and kept its quantitative easing programme (QE) unchanged.

The decisions were made at the first meeting of the Bank's Monetary Policy Committee since Mark Carney took over as governor from Sir Mervyn King.

Share prices rallied in London in anticipation of the further continuation of cheap borrowing costs.

The FTSE 100 index jumped 50 points on the news, and later gained a further lift from a promise by the European Central Bank to keep eurozone rates low, taking it to 3% up for the day.

The unusual statement by the Bank's Monetary Policy Committee (MPC) comes as the economy shows signs of recovery, with several industry surveys pointing to rising business optimism.

Earlier on Thursday the Halifax reported that house prices across the UK were 3.7% higher in the three months to June than a year ago, adding to evidence that the property market is on the rebound, particularly in the South East.

'Not warranted'

The MPC said that the recovery "remains weak by historical standards and a degree of slack is expected to persist for some time".

The positive developments in the economy have also been tempered by a sharp rise on global markets in the long-term cost of borrowing - something that has caught central banks worldwide by surprise.

In light of the market movements, "the implied rise in the expected future path of Bank Rate was not warranted by the recent developments in the domestic economy," the MPC said.

FTSE 100 Index

Last Updated at 27 Nov 2014, 11:36 ET *Chart shows local time FTSE 100 intraday chart
value change %
6723.42 -
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Top winner and loser

easyJet

1633.00 p +
+88.00
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+5.70

Tullow Oil

464.90 p -
-36.10
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-7.21

The Bank has held short-term interest rates at their current historic low level since March 2009.

However, last month markets brought forward their expectations for when interest rates in the UK - as well as in the US and other major economies - would start rising again.

It came after a statement from the US Federal Reserve laying out a timetable for withdrawing its own QE programme was taken as a signal by markets that the era of cheap money was coming to an end, and sent stock markets, commodity and bond prices lower worldwide.

The Bank's statement immediately scaled back those expectations in the sterling money markets.

Even so, the Bank is still expected by markets to raise interest rates by a quarter-point within the next 12 months. Back in April, markets did not expect any change in monetary policy over the coming year or more.

With interest rates expected to remain low for longer, the pound became less attractive on currency markets, sending sterling lower.

The pound also fell sharply against the euro, before rebounding an hour and a half later as the European Central Bank committed to maintaining its interest rates at or below their current level for an "extended period of time", sending the euro lower against all currencies.

Forward guidance?

The Bank of England's move may also herald a change in style with the change of governor.

Start Quote

Today the Bank of England and the European Central Bank tried to declare their independence from the US central bank.”

End Quote

Mark Carney, who has just taken over, is known from his time heading Canada's central bank for favouring "forward guidance" - providing markets with explicit statements about the Bank's future plans, in order to manipulate longer-term interest rates.

The MPC has been asked by the Chancellor George Osborne to make the case for forward guidance in a report to be delivered alongside the August inflation report.

The Bank said the analysis "would have an important bearing on the committee's policy discussions in August".

"This is close to the MPC issuing forward guidance in July, instead of waiting until August," said David Tinsley, UK economist at BNP Paribas.

"It is clear from the statement that they are looking to forward guidance as a key tool in massaging yields and expected Bank Rate lower.

"It is newsworthy in itself that despite better data, the committee as a whole agreed this common view. It suggests at this early stage that Mr Carney is both dovish leaning and very much in charge."

Voting split

Although the no change in policy was widely anticipated by markets, there is likely to be keener market interest than usual in the voting pattern at Thursday's meeting, when minutes are published on 17 July.

The MPC has been split in recent months over whether to increase QE from its current level of £375bn, and the outgoing governor, Sir Mervyn, was among the minority voting in favour of an increase.

It is unclear which way Mr Carney is likely to have voted on the issue, particularly in light of the stronger economic recovery, as well as the recent market jitters over future interest rates.

Further complicating the picture, inflation in the UK remains doggedly high - consumer prices rose 2.7% in May, well above the Bank's 2% target.

Inflation has been above target since 2009, and has been stuck in the 2%-3% range for the past year, having previously fallen from 5%.

The Bank has thus far turned a blind eye to the inflation overshoot - something that is not expected to change under Mr Carney.

Wage rises have consistently failed to keep up with rising shop prices, and this has undermined the purchasing power of households and dampened consumer spending.

 

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