The Bank of England will keep the base rate at 0.5 per cent until the UK’s unemployment rate falls below 7 per cent unless inflation spikes, governor Mark Carney announced today.
Presenting the latest Inflation Report, Carney introduced a policy of “explicit state contingent guidance” when it comes to the Bank’s monetary stance, with a link to unemployment. He also revealed that quantitative easing will not be unwound while unemployment is above 7 per cent.
The Bank is also prepared to add to QE while the unemployment rate remains above its desired level.
However, Carney added that the monetary policy committee will have to consider rate changes if its inflation forecast goes beyond 0.5 per cent of its target over 18-24 months or if there are any threats to financial stability.
“It is important to be clear that bank rate will not automatically be increased when the unemployment threshold is reached. Nor is 7 per cent a target for unemployment,” Carney said.
“So 7 per cent is merely a ‘way station’ at which the MPC will reassess the state of the economy, the progress of the economic recovery, and, in that context, the appropriate stance of monetary policy.”
The use of forward guidance, which was widely expected by the market, follows similar action by the Bank of Japan in 1999 and the US Federal Reserve in 2012. Carney also implemented forward guidance at the Bank of Canada in 2009 when he was governor.
According to the Office for National Statistics, the UK’s unemployment rate currently stands at 7.8 per cent.
The Bank of England expects median unemployment to stand at 7.3 per cent over the next three years, the Inflation Report shows, meaning the base rate is likely to remain at its historic low throughout the forecast period.
Carney said: “It is important to stress that forward guidance does not mean the MPC is promising to keep interest rates low for a particular period of time. The path of Bank Rate and asset purchases will, as always, depend on economic conditions.”
When Carney introduced forward guidance at the Bank of Canada, it was linked to a specific date rather than economic conditions. Some critics had suggested that this approach could have the adverse effect of pushing up inflation.
In a letter to the governor, Chancellor George Osborne says: ”Given the exceptional economic challenges continuing to face the UK economy, I agree with you that forward guidance can play a useful role in enhancing the effectiveness of monetary policy and thereby supporting the recovery.
“I take note of the comprehensive arguments the MPC has set out for the choice of an unemployment threshold. I also note the committee’s important approach of allowing the threshold to be ‘knocked out’ if there are material risks to price stability or financial stability.”