LONDON MARKETS: U.K. Stocks Slump On BOE Rate-hike Fears

By Sara Sjolin, MarketWatch

LONDON (MarketWatch) -- U.K. stocks ended sharply lower on Wednesday after the Bank of England's November inflation report stoked fears the central bank could hike interest rates as soon as 2015 due to a more upbeat assessment of the country's labor market.

The FTSE 100 index dropped 1.4% to end at 6,630.00, the biggest one-day percentage drop since August.

The Bank of England said that the U.K. unemployment rate is more likely than not to reach its 7% threshold by the first quarter of 2015, assuming constant interest rates. That would possibly bring forward a hike in the BOE's key lending rate. Also, if market expectations that interest rates will rise in mid-2015 are taken into account, the threshold is more likely to be reached in the third quarter of 2015, as such rises would dampen growth in 2014 and 2015.

The 7% threshold has become a key level for financial markets ever since the BOE released its August inflation report. That's when the bank laid out its forward-guidance framework and vowed to keep interest rates at a record low of 0.5%, at least until the joblessness rate falls to that level.

At the time, the central bank predicted unemployment would remain above 7% until 2016, but after recent upbeat data, markets have already started to price in a rate hike earlier than that. At a news conference on Wednesday, however, BOE Governor Mark Carney reiterated that reaching the threshold would not necessarily trigger an immediate policy response.

"At a simple level the implication is that the [Monetary Policy Committee] may consider raising rates at an earlier stage than it did three months ago. But, and it is a huge but, we note that the guidance says that the committee aims not to raise interest rates until unemployment has fallen to 7%, which is different from an intention to raise the bank rate when this level is reached," said Philip Shaw, chief economist at Investec Securities, in a note.

"Our reading is that the broad aim of the BOE's guidance is to avoid any perception that a tightening might be imminent, rather than to provide month specific hints over when rates might rise. In this context, whether a hike is two or three years away is very much a side issue," he added.

The British pound (GBPUSD) traded at $1.6027, up from $1.5902 on Tuesday.

The Office for National Statistics said the U.K. jobless rate fell to 7.6% between July and September, down from 7.7% in August. That reading further ignited speculation that the unemployment rate would drop faster than the initial BOE forecast.

Banks were among major decliners in the FTSE 100 index, with shares of Barclays PLC (BCS) 2.8% lower, Lloyds Banking Group PLC (LYG) down 1.5%, and sector heavyweight HSBC Holdings PLC (HBC) off 1.9%.

Shares of J Sainsbury PLC climbed 3% after the supermarket chain reported a 9% rise in first-half profit as it continued to grow its market share.

Outside the main index, ICAP PLC rallied 4.1% after the company reported a 6% rise in first-half operating profit.

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