The Bank of England (BoE) governor Mark Carney has severed the tie between the unemployment rate and a rise in interest rates as he outlined a revamped forward guidance policy.
The governor, speaking today, said the Bank had learned the recovery was “neither balanced nor sustainable” and so had decided to outline the “next phase of guidance” by setting out the factors which would guide its decision to raise rates once unemployment hits 7 per cent.
Mr Carney had previously said when unemployment hit the 7 per cent threshold this would be a “staging post” at which the BoE would consider raising the Bank Rate from its historic low of 0.5 per cent.
But unexpectedly strong jobs data released in January saw the unemployment rate fall strongly to 7.1 per cent - negligibly above the so-called staging post and more quickly than the BoE had predicted.
Now Mr Carney said he wanted to “absord all the spare capacity in the economy” in the next two to three years as this recognised that “spare capacity is both wasteful and increases the risk that inflation will undershoot the target in the medium term”.
The statement from Mr Carney added that the Monetary Policy Committee would give guidance on the scope to absorb spare capacity further before raising rates, that when rates do rise it will be “only gradually” and that any increases should be “limited”.
The last aspect of the revamped forward guidance policy is that the MPC “intends to maintain the stock of asset purchases until the first rise in Bank Rate”.
The governor said the first phase of guidance - meaning the unemployment rate - was about the “conditions that would have to be met before we would even begin to think about raising the Bank Rate”.
“Now we are outlining what we intend to do: close the spare capacity gap over the next few years; why we intend to do it: to keep inflation at target and avoid wasteful spare capacity, particularly in the labour market; and how we intend to do it: first by waiting to raise the Bank Rate until spare capacity has been absorbed further and then eventually through gradual and limited rate increases,” he said.
“The Bank Rate may need to stay at low levels for some time to come. The first phase of guidance gave businesses confidence that the Bank Rate would not be raised at least until jobs, incomes and spending were growing at sustainable rates. As guidance evolves, that remains the case: the MPC will not take risks with the recovery.”