Markets' talk of steep rate rise is mistaken, says George

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The Governor of the Bank of England gave a strong hint yesterday that interest rates would not rise as far or as fast as the financial markets believe.

Sir Edward George warned an audience of analysts and traders not to read too much into the fact the markets were pricing in a massive jump in rates by the end of the year.

He highlighted the market in interest rate futures – traders' bets on the path of monetary policy – which predict that rates would surge from 4 per cent now to as high as 5.25 per cent by the end of the year.

Sir Edward warned the markets against "placing too much weight on the steepness of the short-term interbank interest rate futures curve as an indicator of the likely course of short-term rates, at least in the UK". "Our impression is that it includes quite a significant term premium," he told a bond investors' conference organised by Euromoney magazine.

Sir Edward added that investors might not yet have adapted to the fact that returns from investments would be much lower if the UK really had entered a new low-inflation environment.

The Governor's comments came a week after he took the unusual step for a central banker of dismissing January's jump in inflation as "erratic". The Bank's inflation report, published last week, gave no sign it was in any hurry to raise rates.

There was an immediate reaction in the City, where traders scaled back their implied forecasts for rates at year-end to 5 per cent. Analysts said Sir Edward was trying to dampen expectations of an imminent rate rise in the face of data indicating that the domestic economy was booming.

Inflation rose above target in January thanks to the largest one-month rise in a decade. Meanwhile, the housing market is running at levels not seen since the unsustainable boom of the late 1980s. Consumers have been encouraged to spend – offsetting a manufacturing recession – by the Bank's decision to cut rates by 2 percentage points to a 38-year low.

Philip Shaw, UK economist at Investec, said the Bank was trying to play down speculation of an imminent rate rise. "Given the scale of the domestic and international furore that would be unleashed, the Bank needs to raise rates like it needs a hole in the head," he said. "The Governor's speech seemed to be designed to fend off any pressure to act in the near-term, at least until the global economy gets on to a surer footing."

However it was Sir Edward himself who – unintentionally – sparked speculation of an imminent rate rise earlier this year. He told the BBC the Bank would hike rates unless domestic consumer spending slowed down before the global economy began a major recovery. He later said he did not mean to imply a change was "imminent".

The pound slipped against the dollar although analysts said this was driven more by signs that the US economy had embarked on the path to recovery. The number of US housing starts in January topped expectations by jumping 6.3 per cent to their highest pace in almost two years.

Meanwhile, industrial production in the eurozone rose 0.8 per cent in December, the first monthly rise in the 12-nation region's output since last August.