When the unemployment rate fell below seven percent then we would look at raising interest rates, said the Governor of the Bank of England (BoE), Mark Carney, under his policy of forward guidance.

He did however put in place a number of stoppers to ensure it was not an automatic event.


In its latest inflation report the BoE acknowledges that the unemployment rate will fall below that magic number but that rates would not be going up because of the amount of slack (unused portion of the economic productive capacity) still in the UK economy.

Commenting Katja Hall, CBI Chief Policy Director, said:

The recovery is taking hold, and we’re seeing signs that business investment and trade are starting to make greater contributions to growth. But there is still considerable slack in the economy, so now is not the time to raise interest rates, as the Governor made clear.

Forward guidance has clearly been effective in influencing companies’ expectations of when interest rates will rise and in cementing their confidence in the recovery.

The Bank’s new guidance will give businesses further peace of mind that interest rates will stay low for some time, until investment and incomes are growing at sustainable rates. And the Bank has made clear that even when the economy is operating at more normal levels, rates will only increase gradually.”

Manos Schizas, Senior Economic Analyst at ACCA (the Association of Chartered Certified Accountants) commented:

The Governor is right to highlight the shakiness of the recovery. His reassurance that ‘exceptional support’ will be maintained for years, and that interest rates will rise only gradually afterwards will of course be welcomed by markets, businesses and households. It’s interesting that the Bank does not see their projection of a falling household saving rate (which will stand at 3% in 2017) as a destabilising factor.

Bank of England - FreeFoto.com

Bank of England – FreeFoto.com

Forward guidance has now evolved from being tied to a simple indicator (plus caveats) to being tied to a multitude of indicators which will now include unemployment, involuntary part-time work, hours worked, participation, labour productivity, wages, and a range of indicators of spare capacity in businesses. On the one hand, this will reassure those who say the recovery is not yet robust enough for the Bank to ease up on its stimulus – and this is the Governor’s view as well. On the other hand, making a call against all of these multiple variables is more art than science, which will create more uncertainty.

What we do know with some certainty is that the Bank’s priority now appears to be that spare capacity in the economy be absorbed before it can begin to withdraw its stimulus. A close look at the indicators of labour market ‘slack’ that the BoE intends to use, however, suggests that it is developments on underemployment that will mostly delay interest rate rises – other indicators are improving very rapidly. Quite how well underemployment corresponds to under-utilisation of capacity in businesses remains to be seen of course.”

Peter Spencer, Senior economic adviser to the EY ITEM Club said:

Today’s update to forward guidance was inevitable, with the recent improvement in unemployment having forced Mark Carney’s hand.

The new policy can be boiled down to an output gap target. But while this may be theoretically sound, it presents a range of practical problems, not least because it cannot be measured. The Treasury’s latest survey shows a range of 0.8% to 6% for the current size of the output gap, demonstrating the challenge of targeting this measure. It is also going to be difficult to communicate it effectively to the markets. In short, the Bank has set themselves a much more complex task.

Carney has insisted that rates will remain low for some time, which should put to bed the uncertainty surrounding the immediate path of monetary policy. But the outlook for the next couple of years is less certain and there will be an onus on the MPC to steer the markets through greater levels of communication, in particular more interviews and speeches.

The Bank’s new guidelines for the pace of tightening do not alter our view that the first rate rise will come in 2015Q3. The Bank’s new guidance makes it clear that it wants to see a sustained pickup in real wages and a more balanced recovery and this timeframe should allow that to happen. It is also consistent with the inflation fan chart, where below target inflation over the medium-term points to an expectation of a slightly lower path for rates than the market anticipates.”

Sasha Nugent, Caxton FX analyst, said:

The rise in UK growth forecasts seems to have supported the market’s expectation of a rate increase in the first quarter of 2015 from the BoE. The adjustment in forward guidance to focus on absorbing spare capacity as well as a number of broader measures has failed to dampen interest rate expectations.

"Despite the fact that the central bank does not yet think growth is sustainable, the market continues to draw their own conclusions and as long as UK growth remains on track demand for the pound is unlikely to ease.

"Considering the unexpected strengthening of the  labour market after forward guidance was introduced in August, it is no surprise the market is supporting its own projection about the likely timing of monetary policy tightening.

Kevin Doran, Senior Fund Manager at Brown Shipley, commented:

As anticipated, Carney focused on spare capacity, additional slack and output gaps. Whilst many commentators will focus on the reduction in the equilibrium level of unemployment, the big take-away here is the commitment to not raise rates back to 5%, even after the recovery.

This is significant, since the mechanics behind that have to be an assumption that the longer term rate of potential growth in the UK economy have fallen. For ever. Or if that is not the case, then the Bank have effectively just dropped their Inflation Target mandate. It is one of the two.

With the unspoken nature of monetary policy being to create higher inflation. This will lead to asset price bubbles, something they have tried to head off by promoting the importance of the Financial Policy Committee, but the world has changed. We are seeing a new paradigm  today.”

Paul Sedgwick, Head of Investments at Frank Investments, said:

Today’s announcement was a clear statement of intent to keep rates lower for longer, reliance on unemployment rates alone, to manage interest rates, had left him no room to manoeuvre when employment rates fell quicker than anticipated.

The concept of forward guidance still remains and the scope for that guidance has been broadened. Lack of wage growth and spare capacity in the economy, ensures inflation will lag economic growth.

The yield curve is about right at the moment, when rates start to rise the first moves will be modest. Unemployment rate has fallen faster than anticipated and is expected to reach his threshold in the Spring. Despite this, his comments ensure the likelihood of a rate rise at that time is minimal.

Carney estimates economic growth this year will rise from 2.8 per cent to 3.4 per cent, meaning we will see real economic growth this year of 1.4 per cent. Alongside low rates, subdued inflation should provide an ideal backdrop for equity investors this year."

Comment Here!