Financial markets no longer set for 'unpleasant surprise' on interest rates, says Bank official

Financial markets will no longer face an "unpleasant surprise" after the Bank of England primed investors for a potential interest rate hike later this year, according to a Bank official.

Ian McCafferty, a member of the Bank's Monetary Policy Committee (MPC), said efforts had been made to ready markets for a prospective rate rise because many investors felt no action would be taken until after Brexit.

He said the MPC had become concerned that the markets were misreading the Bank's ability to react, which may have triggered an "unwelcome snapback" in bond yields.

Speaking at the Founders' Company in London, he said: "Until recently, financial markets had appeared to believe that, almost regardless of how the economy behaved, Brexit-related uncertainties effectively tied our hands until after the United Kingdom had left the European Union.

"This, we felt, was a misreading of our reaction function, risking unnecessary surprise and therefore an unwelcome snapback in bond yields were the policy stance to change."

Mr McCafferty and Michael Saunders are among the most hawkish members of the nine-strong committee and have already voted in favour of interest rates rising from historic lows of 0.25%.

While the pair were outvoted 7-2 in September - resulting in rates being kept on hold - other committee members are now entertaining the idea of interest rates moving higher.

Mr McCafferty added: "More explicit guidance was redeployed in the September minutes specifying that, for a majority of MPC members, 'if the economy continued to follow a path consistent with the prospect of a continued erosion of slack and a gradual rise in underlying inflationary pressure, some withdrawal of policy stimulus was likely to be appropriate in the coming months'.

"This has had the effect of bringing forward expectations of the first rise in Bank rate from mid-2019 to late 2017, reducing the risks of an unwelcome surprise."

Mr McCafferty also issued a defence of the Bank's ability to support the UK economy despite criticisms that quantitative easing (QE) is losing its power.

He said QE, which involves the Bank creating new money electronically in order to buy financial assets, was not exhausted and the Old Lady of Threadneedle Street had not "run out of ammunition".

QE can help the Bank push inflation back towards its 2% target by driving down the cost of borrowing and bolstering asset prices to support spending.

Focusing on when to wean the economy off the mammoth money-printing exercise, Mr McCafferty said there was no need to start unwinding QE until the "Bank rate has increased several times".