July 30 2014 Latest news:
Wednesday, February 12, 2014
The Bank of England today abandoned its flagship forward guidance policy linking interest rates to unemployment after just six months but insisted they must remain low for longer to support the economy.
Governor Mark Carney said that despite the best pace of growth since before the recession, the recovery had been “neither balanced nor sustainable” and required continued support.
He indicated interest rates would have to stay well below the pre-downturn average of 5% for the next few years - a move designed to help borrowers but that will see savers continue to suffer after five years in which they have remained at 0.5%.
The Bank pledged in August that it would not consider a rise until unemployment fell to 7%, in a bid to reassure businesses and homeowners about the cost of borrowing.
But with the target due to be hit imminently, the guidance has been replaced with policy based on a more complex framework linking rates to the output gap in the economy as measured by a series of 18 indicators.
At the time it was set, the threshold was not expected to be reached until 2016 but since then half a million more people have found work. Mr Carney said it was now expected to be reached in the spring, prompting the policy to be reassessed.
He pledged that when rates do go up the rise will be gradual but refused to promise there would be no hike this year.
Markets brought forward expectations of an increase to April 2015, helping the pound climb against both the dollar and the euro.
The governor said continuing difficulties facing the economy meant rates would have to be “materially lower than before the crisis”, citing a forecast that sees them approaching 2% in 2017.
Mr Carney said: “The recovery has gained momentum. Output is growing at the fastest rate since 2007, jobs are being created at the quickest pace since records began, and after four years above target the inflation rate is back at 2%.”
The governor was speaking at the launch of the Bank’s quarterly inflation report, which upgraded its growth forecast for this year from 2.8% to 3.4%.
Meanwhile the Bank’s chief economist, Spencer Dale, said wages were now expected to return to above-inflation growth by the second half of this year after a prolonged period during which real pay has been falling.
Mr Carney said the recovery had been underpinned by a revival in confidence, a reduction in uncertainty and an easing in credit conditions. This had seen households save less and spend more, and the housing market strengthen.
Business investment remained subdued but was likely to gather pace this year, the governor added. Despite the improving economic picture, productivity growth has been disappointing.
He added: “The recovery is neither balanced nor sustainable. A few quarters of above trend growth driven by household spending are a good start but they aren’t sufficient for sustained momentum.”
“If and when the time comes that the economy can sustain higher interest rates, Bank rate is expected to rise only gradually. For a sustained and balanced recovery, the degree of stimulus will need to remain exceptional for some time.”
Economic activity remained below its pre-crisis level while wage growth was weak and the household savings rate was likely to fall further, he said, while risks remained from global markets.
The so-called “slack” or spare capacity gap in the economy, demonstrated by poor wage growth, was at around 1-1.5%.
New guidance sets out that that the MPC wants to absorb all this capacity over the next two to three years and that there remains more “scope” to make progress on this before the next rate rise.
The £375 billion quantitative easing pumping money into the economy will also remain the same until the rise happens.
Mr Carney defended the first phase of guidance, saying it had boosted confidence in UK economic prospects and encouraged firms to hire and spend.
But he indicated that had the strength of the recovery path been known at the time it was set out, the threshold would have been lower.
There was speculation that sceptical members of the Monetary Policy Committee may have been reluctant to adopt another specific target tying the Bank’s hands when they re-visited the policy only a few months later.
Economists said the lack of clarity of the new guidance compared to the binding link to unemployment meant there would effectively be a return to looking at the path of inflation to predict when interest rates might change.
The rise in the cost of living is expected to remain around the Bank’s 2% target rate for the time being, meaning there is currently little pressure for a rise - which could be prompted should it look like spiralling.
The overhaul of the Bank’s guidance has been seen as a test of Mr Carney’s credibility, with the policy coming under pressure since he oversaw its introduction last summer shortly after he began his tenure as governor.
Simon Smith, head of research at FXPro, said the new guidance introduced a “fog of new forecasts” to predict policy.
Jonathan Loynes of Capital Economics said: “This ‘second phase’ of guidance obviously lacks the simplicity of the previous one.
“And there is a clear concern that, in putting more focus on the general degree of spare capacity, it replaces the unemployment rate with an even more unpredictable, and much less observable, economic concept.
“Indeed, perhaps the main effect of the changes to forward guidance will be to shift the focus back on the outlook for inflation.”
Ben Brettell, of stockbrokers Hargreaves Lansdown said: “The real message from today is that Mark Carney intends to keep rates low for as long as possible.
“This is clearly bad news for savers, but it’s good news for investors and borrowers.”
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