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The Bank of England (BoE) has changed its view on interest rates following the publication of the November Inflation Report.

Governor Carney explained that stronger-than-expected demand has helped the unemployment rate to fall faster-than-expected, and the BoE now forecasts the unemployment rate to hit the Bank’s 7% threshold in the second half of 2015 (compared to previous guidance, which assumed the threshold not being met before the middle of 2016). The latest figures on the unemployment rate showed a fall to 7.6% in the three months to September. The change in guidance suggests the BoE will begin considering raising interest rates over a year earlier than it thought only three months ago. 

The BoE also raised its average annual growth (GDP) forecast over the forecast horizon by about a quarter of a percentage point, but also cut its average annual inflation forecast by about 0.3%, suggesting a better trade-off between growth and inflation. Indeed, when comparing the two forecasts that the Monetary Policy Committee provided this month, the first predicated on constant interest rates and the second on market interest rates (which are higher), the forecast using market rates has inflation just below 2% at the end of the forecast horizon, while the forecast using constant rates shows just above 2% inflation. This suggests that the Bank thinks the market is too aggressive in forecasting the first rise in interest rates in the middle of 2015. However, keeping interest rates on hold until the end of 2016 would, on the other hand, be too late.

Given the update in views and analysis from the November Inflation Report, the Bank appears to be turning more hawkish, although it also continues its non-committal stance to its 7% unemployment rate threshold. On balance, this leads us to bring forward our forecast for the first interest rate rise from the end of 2016 to the start of 2016, but we are not confident enough in the sustainability of the recovery to forecast tightening monetary policy in 2015, especially due to the poor productivity growth seen. The UK’s recovery has considerable momentum going into 2014, but whether the debt-fuelled housing recovery translates into anything more than a short-term rebound in demand is questionable, particularly in the absence of wage growth outpacing inflation.

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