Interest rates could rise to 2.25pc in three years

Given that markets previously expected the first rise in the Bank base rate to come in Q1 2015, the Governor has raised the prospect of a rise in rates later this year.

Speaking at the Mansion House Bankers and Merchants Dinner in London last night, he said: “The task a year ago was to secure that recovery in the face of continued domestic frailties and ongoing international weaknesses.

“At home, unemployment and underemployment remained elevated, productivity growth was anaemic, and debt levels were high. Abroad, the European crisis had moved only from its acute to its chronic phase and financial markets were demonstrating their fragility during the ‘taper tantrum’.

“With this backdrop and with real wages around 10% below their pre-crisis levels, it was not surprising that consumer confidence, though improved, remained low. Business confidence was similarly shaken by past shocks and current scepticism about the ongoing strength of demand.

“The Bank responded to these challenges.

“Forward guidance gave households and businesses confidence that Bank Rate would not be raised at least until jobs, incomes and spending were growing at sustainable rates. Guidance encouraged businesses to hire and spend, and helped keep expected interest rates low, even as the economy recovered strongly...

“We are now faced with the challenge of turning that recovery, which has steadily gained momentum and breadth over the past year, into a durable expansion...

“There’s already great speculation about the exact timing of the first rate hike and this decision is becoming more balanced.

“It could happen sooner than markets currently expect.”

However, having delivered such a blunt message the Governor then went on to emphasise the challenges that the UK economy still faces and said that the rate rises would be gradual and minimal.

“The MPC has rightly stressed that the timing of the first Bank rate increase is less important than the path thereafter – that is, the degree and pace of increases after they start,” he said.

“In particular, we expect that eventual increases in Bank rate will be gradual and limited. That is because the economy will face the ongoing challenges of public and private balance sheet repair, a 10% appreciation of sterling over the past year or so, and muted growth in our main export markets.

“Caution over the path of rate increases once they begin is also needed because we start at a point from which interest rates cannot easily be reduced. The effects of an excessive or an excessively rapid tightening of monetary policy could prove damaging and difficult to undo.

“Perhaps for these reasons, financial markets expect Bank rate to rise to only 2.25% over the next three years.”