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Bank of England Hold Interest Rates Due to Inflation

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Bank of England Hold Interest Rates Due to Inflation

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Britain's recent spell of low inflation has been largely down to a dramatic fall in oil prices, a phenomenon which Mark Carney, Bank governor, hailed as "unambiguously good" for economic growth. Latest inflation figures showed prices increased just 0.5pc in the year to December, the joint lowest on record.

In Mr Carney's first open letter to Chancellor George Osborne since he joined the Bank in August 2013, the Governor said falling prices did not signal that Britain was entering a protracted period of deflation. He added that the decline in the oil price - which has halved in the last eight months - would help to sustain the recovery and keep wages growing faster than prices.

On Thursday he added that that around two thirds of the shortfall between actual inflation and the Bank's 2pc target was down to a "sharp fall in food and energy prices", considered "good deflation". The remainder, he said, was down to subdued inflationary pressures domestically, or "bad deflation".

Nonetheless, the Bank said it was prepared to cut rates below their already rock bottom level of 0.5pc, or add to its £375bn stockpile of asset purchases if inflation remained persistently below target.

Mark Carney, the governor of the Bank of England, said that the Bank had the "means, will and responsibility" to return inflation to the Bank's 2pc target.

Mr Carney was careful to stress that the Bank is not yet considering extra stimulus, but that it had "many options" for doing so in the event of prolonged low inflation.

Explaining why inflation had fallen by more than 1 percentage point below the Bank's 2pc target, he said: "A temporary period of falling prices driven by large adjustments in a few specific components of the CPI is a fundamentally distinct phenomenon from 'deflation', which is characterised by persistent and generalised decline."

The Bank believes the effect of falling oil prices will wear off after about a year, with little effect on inflation in the long run.

It expects CPI to return to the Bank's 2pc target within two years, and then slightly overshoot it by 2018. The Bank also maintained its forecast that the economy would expand 2.9pc in 2015, which would be its strongest growth in nine years.

Mark Carney at the Bank of England (DAVID ROSE)

It said the temporary boost from oil would boost household incomes and consumer spending, which the Bank expects to increase from 3.5pc this year, from a projection on 1.25pc just three months ago.

This will drive an increase in consumer spending, which is expected to grow by 3.75pc this year, from a projection of 2.5pc in November.

The Bank also said that if the fall in oil prices boosted growth more than expected, the Bank would increase rates "more quickly than embodied in current market yields". Markets believe rates will not rise to 1.5pc until 2020.

Average weekly earnings, which are already growing at above 2pc in the private sector, are expected to return to close to their pre-crisis average by 2017, which would compensate for slower than housing and business investment and export growth.

Mr Carney also told reporters that while an acrimonious eurozone exit by Greece would affect the Bank's economic forecast, that it would not have the same impact as it would have done in 2012.

Earlier this month, Mr Carney said that the Bank had the "means, will and responsibility" to return inflation to the Bank's 2pc target.

However, the Bank stressed that "those increases would still be more gradual and limited than in previous tightening cycles."

Inflation Report (PDF)
Inflation Report (Text)

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UK heading for deflation says Bank of England Governor Mark Carney

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Britain's recent spell of low inflation has been largely down to a dramatic fall in oil prices, a phenomenon which Mark Carney, Bank governor, hailed as "unambiguously good" for economic growth. Latest inflation figures showed prices increased just 0.5pc in the year to December , the joint lowest on record.

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Heathrow Boss Warns France is Overtaking the UK

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Heathrow Boss Warns France is Overtaking the UK

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The UK needs to add more flight routes if it is to boost the potential of small businesses to export, Mr Holland-Kaye said.

"You want to export more, and politicians want you to export more - it is the only way to address the UK's balance of payments deficit - but how can we unless we expand Heathrow?"

He dismissed expanding Gatwick as a possibility, saying that Heathrow will create almost twice as much economic benefit as expanding Gatwick and almost four times as many jobs. Up to 180,000 jobs would be created, giving a £211bn boost GDP - that is almost twice the annual NHS budget, he said.

He pointed to the example of Ben Murray, a Scottish entrepreneur who runs shellfish business Keltic Seafare. Mr Murray supplies langoustines from local fisherman to restaurants, and has potential customers in Singapore. His choices are to take a flight from Inverness to Amsterdam and then to Singapore, or to drive them to Glasgow Airport for the shuttle to Heathrow.

"You can't help but wonder how much more he could export if we could make it easier for him to get to market, with a direct flight from Inverness to Heathrow. The airlines are keen - but because Heathrow is at capacity, they can't get slots to do so," Mr Holland-Kaye said.

Keltic Seafare supplies langoustines to Michelin starred restaurants across the UK

A lack of available take-off and landing slots at the West London airport is restricting the number of domestic routes available, making it harder for people who live outside of the capital to reach long-haul markets, supporters of Heathrow's expansion say.

However, Gatwick's chief financial officer Nick Dunn said the Sussex airport deserved a new runway. "Only Gatwick can deliver the economic benefit and the extra capacity the UK needs at an environmental cost it can afford. Gatwick expansion will also deliver more competition between airports serving London and the UK, as well as greater competition within airlines, offering passengers more choice and helping keep airfares lower."

The Airports Commission will recommend in the summer whether to expand Heathrow or its rival Gatwick.

Recent figures show that Heathrow has lost the crown of the world's top airport for international travel. Dubai International handled 69.9m international travellers last year, overtaking Heathrow's 68.1m, according to figures from Airports Council International.

By 2020, Dubai authorities expect its main airport to welcome 98.5m passengers.

The country, which has recently suffered from the oil price drop, has spent years trying to diversify its economy, with core sectors now including trade, transport and tourism.

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Heathrow boss warns that France is overtaking UK for links to Asia

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The UK needs to add more flight routes if it is to boost the potential of small businesses to export, Mr Holland-Kaye said. "You want to export more, and politicians want you to export more - it is the only way to address the UK's balance of payments deficit - but how can we unless we expand Heathrow?"

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John Holland-Kaye has taken over as chief executive of Heathrow, as the airport seeks political approval for a third runway. Aerospace correspondent Andrew Parker asks him what his priorities are, and whether shareholders are willing to foot the bill for expansion.

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► Subscribe to the Financial Times on YouTube: http://bit.ly/FTimeSubs Leader writer James Blitz discusses with Vanessa Kortekaas the FT's big predictions for 2015 - on everything from politics and house prices to oil and Bitcoin.

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The Centre for Economics and Business Research (CEBR) believes Britain will briefly enter deflation in March, when prices are expected to fall by 0.3pc.

However, the Governor has also said that the "oil dividend" could be larger than analysts currently believe.

Mr Carney has described the decline in prices as "unambiguously positive" for the UK, and most estimates suggest the fall will boost UK growth by around 0.5 percentage points.

Last month, he noted that the Monetary Policy Committee (MPC) that sets interest rates recognised that wages were picking up, with average weekly earnings in the private sector already growing by more than 2pc.

The Bank will publish its first open letter to Chancellor George Osborne this week explaining why inflation, which stood at 0.5pc in December, has fallen by more than 1 percentage point below the Bank's 2pc target.

It is likely to say that the nine members of the MPC will "look through" the recent fall in oil prices.

While some policymakers are concerned that the current period of low inflation could alter expectations of future price growth, the forecast is expected to reinforce expectations that inflation will rise back to target as the impact of weaker oil fades.

Some economists believe stronger growth and rising wages mean inflation could overshoot the Bank's target by 2018.

Markets have dramatically pushed back their rate rise expectations over the past six months, and now believe the first increase will not occur until the summer of 2016. Bank of England data show markets believe rates will only rise to 1.5pc in five years time.

Simon Wells, chief UK economist at HSBC, said that while low inflation means policymakers are likely to keep rates on hold until 2016, expectations that rates will be kept on hold for another 18 months could prompt another "Mansion House moment" from Mr Carney to warn that markets have become complacent about rate rises.

"Given that growth is likely to be stronger in 2017, it's not inconceivable that inflation could be nudged up. The MPC will certainly want to send a message that interest rates are not a one way bet or on a pre-determined path."

The Bank is also expected to raise its growth forecasts for 2015 to above 3pc, from a current projection of 2.9pc. However, Mr Carney is likely to reiterate that uncertainty in Europe and weaker growth in emerging markets such as China pose risks to the UK economy.

"The disinflationary forces may be greater than we anticipated. Under those circumstances, until we have a clearer idea of where we are domestically, until some of the international mist clears, then a wait and see policy is probably best," said Peter Dixon, chief UK economist at Commerzbank.

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Interest rates: why they won't rise this year

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The Centre for Economics and Business Research (CEBR) believes Britain will briefly enter deflation in March, when prices are expected to fall by 0.3pc. However, the Governor has also said that the "oil dividend" could be larger than analysts currently believe.

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But even the manufacturing sector weakened at the end of the year, increasing by just 0.1pc in December, compared with 0.8pc a month earlier.

Meanwhile, factory output increased by 2.4pc in December compared with a year earlier, slowing slightly from an upwardly revised 3pc in November, which was the strongest in three months.

Oil and gas extraction fell by 9.3pc on the year, the biggest fall since August 2013. Some of December's weakness was due to extra maintenance in the North Sea's Huntington field, which had been scheduled to be completed in November.

Paul Hollingsworth, UK economist at Capital Economics, said the figure "confirmed that the sector's recovery fizzled out in the fourth quarter".

Many economists expect the declining oil price to act as an economic stimulus, helping growth across all sectors pick up this year. Niesr, an influential think tank, said Britain's economy was on track for its strongest growth in nearly 10 years in 2015 as the oil price plunge put money in the pockets of the country's free-spending consumers.

Mr Hollingsworth said lower oil prices would stimulate heavy industry in particular by making some production lines profitable again.

But he cautioned that given the strength of the pound and weakness in demand from the eurozone that any pick-up in the pace of a manufacturing recovery would be "fairly modest".

Britain's economy grew by 2.6pc in 2014, the fastest growth rate of any big advanced economy, but lost pace towards the end of the year, including in the manufacturing sector which is exposed to weakening demand in the eurozone.

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UK industrial production falls 0.2pc in December

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But even the manufacturing sector weakened at the end of the year, increasing by just 0.1pc in December, compared with 0.8pc a month earlier. Meanwhile, factory output increased by 2.4pc in December compared with a year earlier, slowing slightly from an upwardly revised 3pc in November, which was the strongest in three months.