By William Schomberg
LONDON (Reuters) - Bank of England Governor Mark Carney this week faces the growing challenge of explaining why the central bank is signalling it is in no rush to raise record low interest rates, even as Britain's recovery picks up speed.
The Bank is due to give new inflation and growth forecasts and hold a news conference on Wednesday against a backdrop of soaring house prices in many parts of the country and a faster growth rate than any other big rich nation.
The Bank has struggled to give a clear steer about its interest rate outlook since adopting so-called forward guidance as a policy last year, shortly after Carney took over and just as Britain’s economy was kicking into top gear.
The Bank has said it thinks the recovery can carry on without inflation taking off, allowing it to keep interest rates at 0.5 percent for possibly another year to nurse Britain's economy back to full health.
Central to the argument is the Bank's belief that companies can squeeze more out of their workers and machines as demand grows, avoiding a surge in wages that could fuel inflation. Helping them has been a fall in price growth to a four-year low.
But questions are growing about the assumption that underpins the Bank's relaxed stance: that productivity will grow on the back of strong demand.
Britain's surprisingly strong bounce-back has come with a surge in hiring which the Bank did not predict and which shows little sign of cooling.
Shortly before Carney begins his news conference at 0930 GMT on Wednesday, data is expected to show the unemployment rate fell again to 6.8 percent in the three months to March.
Britain's economy remains a touch smaller than before the financial crisis and wages are only starting to recover ground lost to inflation in recent years.
But the pace of the turnaround and speculation that some BoE policymakers may be getting restless about keeping rates on hold will test Carney's powers of persuasion.
"We think there are risks that the (news) conference will reinforce the view that rates could even rise this year," economists at BNP Paribas said in a note to clients.
Capital Economics, a consultancy, said it was possible that the unity among policymakers on keeping rates unchanged ended at its meeting last week. Minutes of that meeting will be published on May 21.
Economists mostly expect at least one policymaker to break ranks and vote for a rate hike in the coming months.
RATE HIKE THIS YEAR?
As expectations grow that the Bank will raise rates ahead of the U.S. Federal Reserve, the pound last week hit its highest level against the dollar in nearly five years.
Economists said the Bank will probably signal this week that it is comfortable with the view in markets that rates will start going up in the first three months of 2015 - just before Britain holds national elections in May - a calendar quarter earlier than it suggested at the time of its last forecasts in February.
Rob Wood, at Berenberg bank, said there was a stronger than one-in-three chance that rates would go up in late 2014.
Adding to the pressure on the Bank is a jump in house prices which have risen about 10 percent over the past 12 months.
Carney is likely to reiterate that rather than raise interest rates, the Bank will first seek to avoid a housing bubble by controlling mortgage credit, something its Financial Policy Committee could do as soon as next month.
Most attention on Wednesday is likely to be on the Bank's latest estimate of the amount of slack in the economy.
In February, the Bank said it saw spare capacity at between 1 and 1.5 percent of gross domestic product.
Simon Wells, an economist with HSBC, said the Bank might stick to that range but add the caveat that spare capacity is now closer to 1 percent than 1.5 percent in acknowledgement of the speed of the recovery. Other economists said the estimate range could be cut by the Bank.
Economists will also be checking to see if the Bank lowers its forecast for inflation in two years time, a signal to markets that their rate hike bets may be too aggressive.
Giving a steer on its rate plans has become increasingly hard for the Bank. Last year it said it would not consider a hike until unemployment fell to 7 percent. But that took just six months rather than the three years the Bank expected.
By then pegging its thinking on rates to something as difficult to gauge as spare capacity, the Bank gave itself more room for manoeuvre. But it is also likely to give a freer rein to policymakers who favour an early interest rate hike.
(Editing by John Stonestreet)