June 24, 2014 / 11:36 AM / 4 years ago

UPDATE 2-Bank of England nudges back early rate hike bets, says markets underestimate uncertainty

* BoE’s Carney emphasises slack in economy, despite upturn

* Carney says markets did not adjust enough to strong data

* BoE’s Bean: MPC struck by markets’ “certainty” on rates

* Rate hikes to be gradual, Carney says (Adds reaction, detail)

By Andy Bruce and David Milliken

LONDON, June 24 (Reuters) - Bank of England Governor Mark Carney pushed back slightly on Tuesday against expectations that the bank will raise interest rates before the end of the year, saying Britain’s economy still has plenty of slack to work through.

He also said financial markets underestimate how much uncertainty there is in the economy.

Earlier this month markets had priced in a rate rise before the end of the year after Carney said they had underestimated the chance of an early move - a view also shared by the Monetary Policy Committee as a whole.

But speaking to lawmakers on Tuesday, Carney said his intention then had been to encourage markets to take a closer look at strengthening economic data, rather than signal a rate move at a specific point in time.

“We’d like to see the market adjust to the data, just as our opinions are updating. We hadn’t seen (that),” Carney said, reiterating that rate hikes, when they come, would be gradual.

Sterling fell after Carney’s remarks, in which he said that British wage growth had yet to pick up as forecast, and that the economy might have more slack, or unused capacity, in it than thought, even if fast growth was rapidly using it up.

“The economy has performed a little bit better in terms of actual outturns (and) has more momentum than we would have expected,” Carney said. “We have to balance that against the possibility that we could have more spare capacity to begin with.”

Short sterling interest rate futures <0#FSS:> rose briefly before retreating - still signalling a substantial chance of a rate hike by the end of the year.

BoE Deputy Governor Charlie Bean added that Carney’s speech earlier in the month was not meant to flag a likely date for the first rate hike, but rather to make markets consider a wider range of possible dates for the BoE to start raising rates.

“We were all struck by the high degree of certainty that market participants seemed to have about the timing of the first increase,” he said.

Economists polled by Reuters expect interest rates to rise from their record low 0.5 percent in the first quarter of next year.

Sam Hill, senior UK economist at RBC Capital Markets, said Carney’s remarks were akin to the BoE “taking the stabilisers off the bikes of market participants”.

“(Carney) appears to be feeling the need to remind markets that ... the formulation of market rate expectations should be more sensitive to volatility in the data than it has been,” Hill said.

A lack of volatility in asset prices has also troubled BoE policymakers, with stock markets across the globe hitting record highs and prices for riskier euro zone government bonds gaining strongly, despite hefty geopolitical risks from Iraq and Ukraine.

“Market participants in our view underestimate the extent of uncertainty that is out there. Implied volatilities on a range of assets seem to be unusually compressed, below pre-crisis averages,” said Bean, who retires at the end of the month.

In his last annual report to parliament, Bean also wrote that too early an exit from stimulus could come at the expense of recovering productivity.

Too late an exit - which could cause inflation pressures to build - could be “easily dealt with” by hiking rates.

“That points to a late rather than early exit,” he said. (Additional reporting by Ana Nicolaci da Costa, Kate Holton and Jack Stubbs; Editing by Jeremy Gaunt)

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