BOE Signals Rates Will Rise Faster Than Markets Expect -- 2nd Update

The Bank of England joined other major central banks Thursday in signaling that a long era of easy money is gradually drawing to a close, saying that it anticipates raising interest rates in the U.K. at a faster pace than investors currently expect.

In its quarterly outlook, the central bank cut its growth forecasts for this year and next, but said uncertainties ahead of the U.K.'s departure from the European Union were weakening the economy's ability to meet even those smaller increases in demand without generating inflation.

"The process of leaving the EU is beginning to affect potential supply in the U.K.," said Gov. Mark Carney. "Brexit-related uncertainties are causing some companies to delay decisions about building capacity and entering new markets."

The BOE's stance--after holding its benchmark interest rate steady at 0.25%--was interpreted as dovish by investors, causing a 0.8% slide in the pound to $1.3119 and a fall in gilt yields.

Short-term interest rates in financial markets suggest investors expect the BOE to lift its benchmark rate only twice in the next three years, to 0.5% late next year and to 0.75% in mid-2020. But officials said they expect that borrowing costs will need to rise more swiftly to keep inflation in check.

"We think that would be insufficient relative to what would be required to fulfill our mandate," Mr. Carney said.

The signal from London comes as accelerating growth in the 19-nation eurozone cements expectations that the European Central Bank will begin to phase out its stimulus measures next year as the region emerges from the shadow of the past decade's financial crisis.

In the U.S., the Federal Reserve remains on course to raise short-term borrowing costs later this year despite some nerves over subdued inflation. Officials are also due to discuss shrinking the central bank's holdings of more than $4 trillion in bonds at their next meeting in September.

A steep decline in the pound in the wake of last year's Brexit vote has propelled prices in the U.K. sharply higher, squeezing household budgets and restraining consumer spending.

Mr. Carney said that while some British households would be troubled by a rate increase because they have large debts, most are in better shape following a decade of cutting their borrowings.

"We're in a position where households are less vulnerable than they were, " he said. "In terms of the overall position, there is an ability to withstand an adjustment to monetary policy if its appropriate."

BOE officials said they expect the effect on prices from the weakened currency to gradually fade but that domestic price pressures--including wage growth--will begin picking up. The central bank forecasts that annual inflation will remain above its 2% target over the next three years if interest rates rise only twice, and the economy grows at the steady but unspectacular pace it predicts.

Minutes of officials' discussions show that two members of the eight-strong rate-setting panel voted this month for an immediate rise in borrowing costs but were outvoted by a majority that favored staying on hold for now.

The BOE said it expects the U.K. economy to expand 1.7% in 2017, a weaker pace than the 1.9% it forecast in May. It also cut its forecast for growth in 2018, to 1.6% from 1.7%. The downgrades reflect weaker forecasts for consumer spending and business investment. Officials expect higher exports to offset some of that softness.

The BOE's forecasts assume the U.K. negotiates a smooth departure from the EU, expected in March 2019. Officials from both sides are due to meet for fresh talks in October.

Mr. Carney said it was important for there to be a period after the U.K. leaves the EU in which businesses and households could manage the transition to the new relationship, rather than face a sudden change.

"We think it is important to have a transition arrangement," he said. "It's clearly in interest of both side to have a smooth transition."

Write to Jason Douglas at jason.douglas@wsj.com and Paul Hannon at paul.hannon@wsj.com

(END) Dow Jones Newswires

August 03, 2017 09:30 ET (13:30 GMT)