The Bank of England sees slower economic growth going forward, citing lower productivity and sterling strength, and suggested that the interest rate would be raised by the middle of 2016. Further, inflation is expected to return to its 2 percent target within two years.
The economy is forecast to expand 2.5 percent in 2015, slower than the prior projection of 2.9 percent, the central bank said in its quarterly Inflation Report, released Wednesday. The bank forecast 2.6 percent growth for next year instead of 2.9 percent.
Growth is projected to be at or a little below its historic average throughout the forecast period.
The Monetary Policy Committee assessed that the amount of slack narrowed over the past six months and remains broadly in the region of 0.5 percent of GDP.
According to the report, inflation will rise notably around the turn of the year. It is expected to rise further as wage and unit labor cost growth picks up and the effect of sterling’s appreciation dissipates.
As the drag from domestic slack continues to fade, inflation is projected to return to target within two years and to move slightly above the target in the third year of the forecast period, the BoE said.
The forecast is based on the assumption that the bank rate would rise gradually to 1.4 percent by the second quarter of 2018.
The outcome of the financial crisis still poses headwinds to the U.K. economy, Governor Mark Carney said at the press conference.
Officials expected these headwinds to merit “not only a more gradual rate of increase in Bank Rate than in previous cycles, but also require levels of Bank Rate to remain below average historical levels for some time to come,” he said.
Vicky Redwood, chief UK economist at Capital Economics, said the report supports financial markets’ assessment that the MPC is in no rush to raise interest rates. She expects rates to end 2016 at just 1 percent and 2017 at 1.5 percent.
IHS Global Insight’s Economist Howard Archer said as the Conservatives set to press ahead with major spending cuts in the next two to three years, it is very possible that the BoE will take interest rates up even more slowly.
Any hit to economic activity coming from increased uncertainty over a referendum on EU membership in 2017 could also cause the BoE to temper interest rate hikes, Archer added.
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