Mark Carney faces grilling over interest rates plan

Carney: balancing act over policy. Picture: PA

Carney is due to deliver his maiden speech on Wednesday at an event in Nottingham and is expected to defend his controversial use of forward guidance when he answers questions from business leaders. His speech comes as stock markets are already pricing-in a rise in interest rates ahead of the Bank’s expectations.

This month, Carney used the quarterly inflation report to signal that the central bank wouldn’t raise interest rates beyond their record low of 0.5 per cent until unemployment falls below 7 per cent.

At the same time, the Bank predicted a slow recovery, with unemployment not expected to fall before late 2016.

But Carney also outlined “knockout” conditions that would change his guidance policy, including if inflation rises above 2.5 per cent or if the Bank’s policy of printing money – quantitative easing (QE) – was to threaten “economic stability”.

The guidance was largely welcomed by businesses as a sign that they could borrow cheaply and unleash investment. But last week’s upward revision of second quarter gross domestic product growth – up to 0.7 per cent from 0.6 per cent – has seen UK gilt yields and the value of sterling rise as analysts fear the improving economy could kick-start inflation.

Positive figures from the construction, manufacturing, retail and services sectors have also boosted the price of UK government bond yields.

Colin Edwards, an economist at the Centre for Economics & Business Research, said that since Carney took over from Lord King last month, the Bank has been “keen to make it clear what it is doing and why”.

But Edwards says Carney will have to perform a balancing act in Nottingham on Wednesday, with his forward guidance policy having been “undermined by the markets, which continue to anticipate a rise in interest rates in 2015”.

Edwards said: “I would expect to see Mr Carney responding to these expectations in his speech on Wednesday. The test will be whether he is able to strike a tone strong enough to convince markets that we are in for a longer period of low interest rates, or even further QE, without appearing to depart for the bank’s central inflation target.”

Michael Saunders, an economists at Citi, said Carney is likely to adopt a “medium doveish” tone by saying that “the monetary policy committee is prepared to expand asset purchases to back up guidance, but without giving a clear signal of the yield level that would prompt it to act”.

“Such a statement would expand the role of asset purchases from a crisis response – as in 2009 and 2011 – to also include reinforcement for guidance,” Saunders added.

“With this being his first major speech, his words are likely to carry a major impact.”