Bank of England ties rates to jobs, markets unconvinced

LONDON Wed Aug 7, 2013 6:22pm BST

1 of 6. Bank of England governor Mark Carney leads the bank's quarterly inflation report news conference at the Bank of England in London August 7, 2013.

Credit: Reuters/Simon Dawson/POOL

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LONDON (Reuters) - The Bank of England broke with tradition on Wednesday, planning to keep interest rates at a record low until unemployment falls to 7 percent or below, which it said could take three years.

Its attempt to steer expectations about future rate moves and bolster a fledgling economic recovery underwhelmed many investors, who brought forward expectations for when rates would rise from 0.5 percent - the opposite of what the central bank was hoping for - although the move faded later in the day.

Mark Carney, who took over as governor just over a month ago, said a recovery in Britain's economy was underway and appeared to be broadening but had a long way to go.

"We're not at escape velocity right now," he said at his first BoE news conference. "This remains the slowest recovery in output on record."

The Bank said it would consider raising rates if the public's medium-term inflation expectations rise dangerously high; if it forecasts that inflation in 18-24 months will be at 2.5 percent or higher; or if ultra-low rates pose a threat to financial stability, possibly a nod to Britain's housing market.

Some economists said those caveats raised questions about how long the forward guidance was good for and could make it harder for the Bank to reassure households and businesses that borrowing costs will not rise soon.

The U.S. Federal Reserve last year launched a similar plan to keep its interest rates near zero until unemployment falls to 6.5 percent or inflation expectations top 2.5 percent.

"The forward guidance contained in the inflation report was broadly expected but what was unexpected were the get-out clauses," said Lena Komileva at consultancy G+ Economics. "The BoE's pre-commitment to keeping rates at a record low is not as conclusive as it first appeared."

Others said the conditions attached were unlikely to lead to higher rates as the Bank had never previously forecast that inflation would reach 2.5 percent two years ahead or expressed major concern about inflation expectations.

Carney suggested to reporters he was not concerned with signs of a recovery in property prices and that the bank's Financial Policy Committee had tools to tackle financial market bubbles without raising rates.

"I don't think these 'knock-outs' are that substantial," said RBC's Jens Larsen, a former BoE economist who pushed back his forecast for a rate rise by a year to late 2016.

The bigger problem may be explaining the new policy. "This is the challenge for forward guidance - to make it clear to the general public," Larsen said.

"CLARIFICATION"

Carney took over as BoE governor last month, having helped steer his native Canada through the fallout from the financial crisis in 2009 by pledging to keep interest rates low for more than a year.

At the time of his appointment earlier this year, Britain's economy was struggling to show any growth at all. Since then, however, a string of surprisingly strong indicators have suggested the country is already on the road to recovery.

Carney said the aim of the guidance plan was to serve as a clarification about the Bank's attempts to help revive the economy, rather than serve as a new stimulus itself.

In an interview with Sky News later in the day, Carney said that he was not perturbed by the market's reaction to the guidance, describing it as "very marginal".

"We provided as much clarity as we can," he said.

Adding to the challenge for Carney, some other top policymakers at the Bank have previously expressed concern about tying their hands on monetary policy and potentially risking the Bank's inflation-fighting credibility.

Carney declined to answer a question as to whether the nine-member Monetary Policy Committee, which he chairs, had backed the guidance plan unanimously.

Chancellor George Osborne, who wants "monetary activism" to offset his fiscal austerity push, welcomed the plan and said it was consistent with the government's "absolute commitment" to Britain's 2 percent inflation target.

THREE YEARS' GRACE?

The BoE's 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.

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

The central bank now forecasts the economy will grow 0.6 percent during the current quarter, the same as between April and June, and that growth will reach an annual rate of 2.6 percent in two years' time, compared with 2.2 percent forecast three months ago, assuming interest rates stay on hold.

Unemployment is expected to fall only slowly from its current level of 7.8 percent of the workforce, with the central bank expecting it to average 7.1 percent in the third quarter of 2016, the end of its forecast horizon.

This implies that the BoE expects to keep interest rates unchanged until at least that time, unless one of the three conditions is breached before then.

But if the recent spurt of strong economic data persists, the jobless rate could fall significantly faster - particularly if productivity does not improve as the BoE predicts.

Alan Clarke, an economist at Scotiabank, said unemployment falling by 12,500 a month would be enough to bring the jobless rate down to 7 percent by the end of next year.

Inflation is forecast to remain around its current 2.9 percent level for the rest of this year - a lower peak than previously thought - and then to fall roughly as predicted three months ago, hitting its 2 percent target in mid-2015.

(Additional reporting by UK bureau, editing by Mike Peacock)

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