Why interest rates may rise by more than expected

The Governor of the Bank of England, Mark Carney, has warned that investors are underestimating the amount of interest rate rises that will be needed if the UK economy continues to grow as predicted.

In its Quarterly Inflation Report, the Bank upgraded its forecasts for the year, predicting growth will edge higher to 1.5% in 2019, up from 1.4% last year and February's forecast of 1.2%, as the world economy stabilises and Brexit worries fade.

The report said growth is being driven by strength in the manufacturing sector. However, it also found that many companies said growth had stalled at the start of the year, “raising the question as to where the growth would be coming from”, says Sky News.

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Inflation is also expected to rise slightly faster than previously predicted, reaching 2.1% in the coming months, before falling back to 1.7% in the middle of next year.

With the direction of Brexit still uncertain, the all-powerful rate-setting Monetary Policy Committee (MPC) unanimously agreed to hold interest rates at 0.75%.

“Markets are forecasting just one interest rate increase by 2021,” says the BBC, but if there is a resolution to the Brexit impasse, and inflation and growth continue to pick-up, then more increases are likely, Carney said.

“On past form,” writes The Guardian’s economics editor Larry Elliott, “the Bank’s nine-strong MPC would be highly unlikely to tolerate excess demand running at 1% of gross domestic product (GDP) and inflation of 2.2% (and rising) without responding more firmly. Were it not for Brexit, official borrowing costs would probably already be going up.”

Even so, says the Financial Times, the committee “was still in wait-and-see mode”.

Some analysts have said that the bank should have raised rates sooner. “The key message is once again that the markets are too sanguine about the outlook for interest rates,” Ruth Gregory at Capital Economics told The Daily Telegraph.

“The hawkish tone of the Inflation Report supports our view that interest rates will eventually rise more quickly and to a greater extent than markets currently anticipate.”

It’s a risky balancing act, says BBC economics correspondent Dhardhini David: “At the moment, the MPC reckons ‘the cost of waiting for further information is relatively low’, but that, given the degree of inflationary pressure it's forecasting, is quite a gamble”.

“If the Bank has missed the boat, then rates might have to ultimately rise faster and by more than originally envisaged to curb inflation. That would be an unenviable parting gift from Carney to his successor.”