The Bank of England has announced that it is to adopt a policy of forward guidance on interest rates.
The new Governor, Mark Carney announced that interest rates will be linked to unemployment and that a change in base rate from its record low of 0.50 per cent is unlikely until the jobless rate falls to 7.0 per cent or less from its current level of 7.8 per cent.
This would mean that around 750,000 new jobs need to be created to get the rate down to this level.
The Bank of England confirmed today that it expects the unemployment rate to be fall to 7.3 per cent in two years time, suggesting that it will be 2016 before the rate falls to a level that would trigger a review of interest rates and the possibility of them going up.
The Chancellor, George Osborne asked Mr Carney to provide an assessment of the merits of such a policy that means businesses, households and the financial markets will be given advance notice of a change in interest rates, allowing them to plan important financial decisions in a more informed way.
Mr Carney made it clear that once unemployment is down to 7.0 per cent, it does not automatically trigger a rate rise, but will be used as a “way station” for the bank to review its policy.
Mr Carney used a similar policy when he was in charge at the Bank of Canada and which helped Canada escape the worst effects of the global financial crisis in 2009. Today’s announcement is also similar to a strategy currently being used by the US Federal Reserve.
The Bank confirmed that while unemployment is above 7.0 per cent there could be further stimulus through quantitative easing (QE) and that the current £375 billion programme would not be unwound.
Also presenting its Quarterly Inflation Report, Mr Carney confirmed that there was no change from May in its view that inflation will stay at 2.9 per cent this year, but he raised the inflation estimate for 2014 from 2.1 per cent to 2.5 per cent.
Announcing revised and improved growth targets, the Bank said it now expected the economy to grow by 1.5 per cent this year, up from May’s 1.2 per cent estimate and by 2.7 per cent in 2014, a big increase from the prediction of 1.8 per cent just three months ago.
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