Bank of England governor Mark Carney has hinted strongly that interest rates could begin to rise at the turn of the year.
Carney said he expected the bank base rate to rise over the next three years from its current all-time low of 0.5 per cent.
He said rates would likely rise slowly, reaching a level that is “about half as high as historical averages” of 5 per cent.
But he said shocks to the economy and shifts in the exchange rate could impact on the timing and size of any interest rate increases.
His prediction builds on comments he made to the Treasury select committee earlier this week, in which he indicated the UK is “moving closer” to a rise in rates after more than six years at historical lows.
Carney told MPs that Britain is edging towards being able to raise rates based on the strength of the recovering UK economy, which was the fastest growing of the G7 nations last year.
In a speech at Lincoln Cathedral last night, Carney said the monetary policy committee “will have to feel its way as it goes”, adding: “There is, in fact, a wide distribution of possible outcomes around any expected path for bank rate, reflecting the inevitability that the economy will be buffeted by shocks and that monetary policy will have to adjust accordingly.
“Short-term interest rates have averaged around 4.5 per cent since around the Bank’s inception three centuries ago, the same average as during the pre-crisis period when inflation was at target…
“It would not seem unreasonable to me to expect that, once normalisation begins, interest rate increases would proceed slowly and rise to a level in the medium term that is perhaps about half as high as historic averages.
“In my view, the decision as to when to start such a process of adjustment will likely come into sharper relief around the turn of this year.”
Howard Archer, chief UK and European economist at IHS Global Insight, said Carney had reinforced comments from the Bank of England “seemingly preparing consumers and businesses for an interest rate hike”.
He said: “For the time being, we are maintaining the view that the Bank of England will lift interest rates from 0.5 per cent to 0.75 per cent in February 2016.
“But we have become markedly less confident in this call, and there is clearly now a very real possibility that the MPC could act before the end of 2015, most likely in November.”
Carney’s remarks will have further bolstered the pound. A rise in rates – which have been at the historic low of 0.5 per cent for more than six years – had previously not been expected until the middle of 2016.
The pound has already been strengthening against the euro as the fall-out from the Greek debt crisis means the European Central Bank is seen as unlikely to curtail its monetary support for the single currency support any time soon.