Bank of England pegs rates to jobs in new policy

Central bank chief says unemployment will have to fall to 7 per cent before it can raise interest rates from their current level

PUBLISHED : Thursday, 08 August, 2013, 12:00am
UPDATED : Thursday, 08 August, 2013, 5:13am

The Bank of England overhauled its policy strategy yesterday, saying it planned to keep interest rates at a record low until unemployment falls to 7 per cent or below, something unlikely for another three years.

Barely a month after Canadian Mark Carney took over as governor, the central bank said it would keep interest rates at 0.5 per cent unless inflation threatened to get out of control or there was a danger to financial stability.

Carney said a recovery in Britain's fragile economy was under way and that it appeared to be broadening but he warned that it had a long way to go before it was on solid ground.

"This remains the slowest recovery in output on record," he told his first news conference since taking over at the bank. "We're not at escape velocity right now."

The British pound rallied after an initial fall on the announcement and British government bond prices were lower as the BOE's commitment on interest rates fell short of some expectations of a more aggressive plan to revive growth.

"It looks like rates are not going to rise in the next three years, though they could, as Carney has stressed they are not pre-committed, so again this is a rather valueless bit of 'forward guidance' as is the case with the ECB," said Mark Ostwald at Monument Securities.

The Bank of England followed the US Federal Reserve's approach by setting an unemployment target rather than committing to keeping rates low for a set period of time but included get-out clauses. BOE policymakers said they stood ready to buy more government bonds if additional stimulus was needed and would not reverse existing purchases while unemployment was too high.

The central bank said inflation was forecast to stay above its 2 per cent target until the second half of 2015 based on market rate expectations.

"Attempting to return inflation to the target too quickly risks prolonging the period over which the nation's resources are underutilised," it said.

A growing number of major central banks are providing so-called forward guidance to help nurse their economies back to health.

For the Bank of England, the challenge is to hold off a premature rise in British borrowing costs at a time when signs of economic recovery at home and the Fed's decision to phase out stimulus are pushing up market interest rates.

Last month its monetary policy committee took a step towards guidance by saying that a rise in British market rates was not justified by economic fundamentals.

Markets already did not expect the bank to start to raise interest rates until late 2015 at the earliest.

The bank said Britain's economy had strengthened over the past three months. But output still remains more than 3 per cent below its pre-crisis peak, a much weaker recovery than in the United States or Germany.

It now forecasts the economy to grow 0.6 per cent during the current quarter and that growth to reach an annual rate of 2.6 per cent in two years, assuming interest rates stay on hold.