Bank of England vows rates will stay low until unemployment hits 7%

The Bank of England has pledged to keep rates at their lowest level in its 300-year history until unemployment falls to 7 per cent, hoping the commitment will help nurture the nascent recovery in the world’s sixth-biggest economy.

Marking a significant shift in strategy by the central bank under new governor Mark Carney, the bank yesterday provided more explicit guidance to markets and the public that monetary policy would remain loose until the economy returned to better health.

Mr Carney, one of central banking's earliest and most vocal advocates of so-called forward guidance on policy, said the Monetary Policy Committee would keep benchmark interest rates at 0.5 per cent until the unemployment rate fell from its current level of 7.8 per cent to 7 per cent.

Need for 750,000 jobs
The MPC does not expect that until mid-2016. A return to 7 per cent unemployment would equate to the creation of about 750,000 jobs.

Mr Carney told his first press conference since he started the job that Britain’s economy was recovering but was still too weak. “This remains the slowest recovery in output on record,” he said. “We’re not at escape velocity right now.”

But the MPC said it would rethink its guidance if inflation was set to be 2.5 per cent or higher in the medium term, if inflation expectations were out of control or if the policy was threatening financial stability.

Markets gyrated as investors tried to digest the new policy. Sterling, which initially fell 0.9 per cent to $1.5207, subsequently gained more than three cents to stand 1.1 per cent higher at $1.5512 against the dollar as forex traders bet against the bank being able to hold off from rate increases until mid-2016.

Equity investors appeared to remain unconvinced the economy could gather momentum without further support and the FTSE 100 fell 1.4 per cent to 6,511.21. The yield on the 10-year gilt, which moves inversely to the price, rose 0.1 basis points to 2.48 per cent.

"The markets' view of the MPC's guidance seems to be that although it might have clarified some aspects of the policy outlook, it is also relatively 'soft' because the accompanying provisos give plenty of room for policy to deviate from the indicated path," said Simon Hayes, an economist at Barclays. "In our view, the markets' interpretation is right."

Mr Carney maintained the bank’s commitment to its inflation target was “unwavering”. Guidance was, he said, “first and foremost” about making the monetary stimulus more effective and lessening anxiety the MPC would tighten rates.

Sir John Gieve, a former Bank of England deputy governor, said: "It's not really a change of policy, but a change of policy explanation."

Complex message
However, some economists said the "get-out clauses" made the guidance less robust and harder for the public to understand. "This is not a message to the man on the street given its potential complexity," said George Buckley, an economist at Deutsche Bank. Charles Goodhart, a former member of the committee, said the "great question" was now the speed at which unemployment would fall. – (Copyright The Financial Times Limited 2013)