By Canadian Press

UK interest rates set to rise as inflation hits 3 per cent

Oct 17, 2017 | 2:36 PM

LONDON — Inflation is set to rise above 3 per cent in the next month or two, the Bank of England’s governor warned Tuesday, a cautionary note that reinforces expectations interest rates will soon rise for the first time in a decade.

Mark Carney’s comment came after official data showed consumer prices rose 3 per cent in the year to September, from the previous month’s 2.9 per cent rate. The increase, which took the rate to its highest since March 2012, was largely due to rising prices for food and transport.

If it had risen any further, Carney would have had to write to Treasury chief Philip Hammond explaining why inflation is more than a percentage point above the 2 per cent target and what he and his colleagues at the central bank were going to do about it.

In testimony to lawmakers on Tuesday, Carney said he’s “more likely than not” to have to write that letter in October or November.

It’s because of this above-target inflation that the bank’s rate-setting panel is expected to raise the benchmark interest rate by a quarter-point from the record low of 0.25 per cent on Nov. 2. After the last meeting, when seven of the nine panel members voted for unchanged rates, Carney warned that rates were likely to rise in coming months largely because of the inflation spike. However, he has stressed that any rate increases would be modest and gradual, partly because of uncertainty surrounding Brexit.

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“Today’s release has all but rubber-stamped a rate hike from the central bank at their next meeting,” said David Cheetham, chief market analyst at online trading firm XTB.

The expected rate rise comes despite the fact that the British economy is faltering — it is growing slower than any other Group of Seven industrial economy — and that inflation is expected to ease in coming months. The pound was little changed by the inflation numbers as most investors have already priced in a likely November rate hike. In early-afternoon trading, it was down 0.3 per cent at $1.32.

One of the main reasons why inflation spiked over the past year is the pound’s 15 per cent or so drop fall since Britain voted to leave the European Union in June 2016. That ratcheted up the cost of imported goods like food and energy, trebling inflation since September 2016.

However, the inflationary impact of the lower exchange rate is set to ease as the annual change of prices due to the pound’s decline drops out of the comparison.

Despite that, many economists think the bank should raise interest rates to give itself room to cut in the future in the event of a recession or financial shock. Others think it could lose credibility if it fails to deliver on a rate hike it had hinted about.

One factor that could dampen expectations for further rate increases is sluggish wage growth. Figures due Wednesday are set to show that wage gains are lagging inflation by about a percentage point, meaning real household incomes are falling.

Carney put his weight behind the need for a transitional deal after Britain leaves the EU in March 2019. He indicated that the outlines of a deal should be agreed on by early next year to keep financial firms in particular from moving ahead with contingency plans that could see them relocate jobs out of Britain.

“There is a limited amount that firms can do in a short period of time,” he told lawmakers in a testimony. “It’s important … that not too much is asked from them.”

He argued that a disorderly exit from the EU is in no one’s interest, especially for financial firms that deal with complicated contracts and cross-border issues of insurance. Though the economic impact of Brexit will be felt most by Britain, Carney said financial issues could be acute for the EU — London is a hub for capital markets for Europe, which could end up being short of access to finance. He insisted he didn’t want questions relating to financial stability to be used as bargaining chips in Brexit discussions.

Fears of a “no deal Brexit,” which Treasury chief Hammond has warned could even see flights grounded, have ratcheted up in recent weeks as the talks between the British government and the EU have appeared to make little headway. Carney conceded that firms have become “less confident about a smooth transition” in contrast to households.

In a speech last month, Prime Minister Theresa May laid out her wish for a transition period lasting around two years after Brexit, during which Britain’s economic and trading relationships with the other 27 EU countries will remain largely as they are currently. A transition deal could also give both sides time to forge a longer-term trading relationship.

“A transition agreement is in everyone’s interest,” Carney said.

Pan Pylas, The Associated Press