Bank links interest rates to unemployment target

 

Bank of England governor Mark Carney: "People need clarity over interest rates"

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Bank of England governor Mark Carney has said the Bank will not consider raising interest rates until the jobless rate has fallen to 7% or below.

Mr Carney said he expected this would require the creation of about 750,000 jobs and could take three years.

The UK unemployment rate currently stands at 7.8%.

The governor told the BBC: "We need to provide as much clarity and as much certainty about the path of monetary policy."

Speaking to chief economics correspondent Hugh Pym, he said such guidance was needed "so that people… at home, people who are running businesses, across the UK, can make decisions - whether they are investing or spending - with greater certainty about what is going to happen with interest rates".

He added: "In effect we are saying - 'we are providing guidance on what could happen with interest rates'."

The governor told our correspondent that such a move was needed now "when the recovery is just gathering some steam", and when financial markets might have therefore been expecting an adjustment in interest rates.

Mr Carney said that the 7% unemployment figure was not a target, but a point at which the Bank of England would re-examine interest rates.

The Bank's guidance is subject to three provisos; breaching any of them would sever the link between interest rates and unemployment levels.

These so-called 'knock-outs' are:

  • CPI inflation is judged more likely than not to be at or above 2.5% over an 18-month to two-year horizon
  • inflation looks like it could get out of control in the medium term
  • the Bank's Financial Policy Committee judges this stance poses a significant threat to financial stability

Start Quote

The Bank's new guidance makes the difficult trade-offs now facing the MPC more explicit. It does not make them go away ”

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'Renewed recovery'

Mr Carney said that until the unemployment threshold was reached the Bank would not cut back on its £375bn asset purchase programme, known as quantitative easing (QE).

The move sees the Bank of England joining both the US Federal Reserve and the European Central Bank in providing so-called "forward guidance" on interest rate policies.

Recent economic figures and surveys have suggested the recovery in the UK economy is picking up pace.

On Tuesday, official figures showed manufacturing output surged in June, while surveys have also indicated gathering strength in the service sector and housing market.

While upbeat on the prospects for the UK economy, Mr Carney said it had not reached "escape velocity" yet.

"A renewed recovery is now under way in the United Kingdom and it appears to be broadening," he said.

"While that is certainly welcome, the legacy of the financial crisis means that the recovery remains weak by historical standards and there is still a significant margin of spare capacity in the economy, this is most clearly evident in the high rate of unemployment."

'Confidence boost'

John Longworth, director general of the British Chambers of Commerce, said the forward guidance would reassure firms.

"This will give businesses a much-needed confidence boost when looking to invest, as they know that any plans will not suddenly be derailed by a hike in interest rates," he said.

Business lobby group, the CBI, echoed this sentiment, saying greater interest rate certainty and clarity from the Bank should provide a shot in the arm for business and households.

But Alan Clarke, director of fixed income strategy at Scotiabank, said unemployment could drop below 7% - the rate that would trigger a re-evaluation of interest rates - well before the Bank of England expects.

Start Quote

Home loan rates look likely to be lower for longer”

End Quote

"Our knee-jerk reaction is that 2016 is a rather conservative assumption," he said. "Our working assumption was that level of the unemployment rate could be reached at least a year earlier."

The possibility of an earlier-than-expected rise in rates lifted the pound on the currency markets, with sterling rising by more than a cent against the dollar to $1.5458.

'Significant caveat'

There had been widespread expectation that Mr Carney would commit the Bank to the new strategy.

With short-term interest rates already at historic lows, the aim is to reduce longer-term interest rates.

Knowing interest rates could remain low, potentially for years, gives banks and mortgage lenders the ability to "lock-in" customers at lower rates for longer.

Stocks fell after the announcement, with Joshua Mahony, research analyst at trading firm Alpari, saying markets had been underwhelmed by Mr Carney's announcement.

He added that rules about the circumstances in which the strategy would be terminated had brought a "significant caveat to the table".

Chart showing the UK unemployment rate since 1993
'Dismay'

The Chancellor, George Osborne, welcomed the move.

"I agree with you that forward guidance can play a useful role in enhancing the effectiveness of monetary policy and thereby support the recovery," he said in a letter to the governor.

Shadow chancellor Ed Balls also applauded the decision but warned it would be "very important that the MPC [Monetary Policy Committee] stays vigilant to inflationary risks".

George Osborne: "I very much support the decision... [People] are going to have greater certainty"

But pressure group Save our Savers expressed "dismay", saying it would cause further hardship for savers and pensioners, while continuing to favour borrowing at the expense of saving.

Meanwhile, Graeme Leach, chief economist at the Institute of Directors, said guidance "doesn't really take us forward" and called for radical supply side reforms to bring on a surge in productivity.

Supply side reforms include lower tax rates and less regulation.

The Bank of England's quarterly inflation report was more upbeat about economic growth than it had been in May.

It presents its forecasts as a range of possibilities rather than a specific figure, but predicted accelerating growth for the rest of this year, with its central forecast being for growth of about 2.4% in two years' time.

It also forecast that the consumer price index (CPI) measure of inflation was likely to be at its target rate of 2.0% during 2015.

The rate of CPI inflation increased to a 14-month high of 2.9% in June, up from 2.7% in May.

Housing bubble?

At the press conference where the new policy was announced, members of the Bank's MPC were asked whether they were concerned by claims the government's Help to Buy scheme was fuelling another housing bubble.

The Help to Buy scheme was launched in April 2013 and allows borrowers to take an equity loan from the government worth up to 20% of the price of newly built homes.

That, in turn, enables homebuyers to put down a deposit of as little as 5%.

From January next year, it will be extended to help buyers of existing housing.

Critics claim the scheme is artificially inflating house prices, leading to future problems when the support is withdrawn.

But Bank of England chief economist, Spencer Dale, said it was important to keep the size of the scheme in perspective.

"The current run rate of [Help to Buy] is something like 3% or 4% of total housing transactions," he said.

"It's done its job in terms of encouraging new house building, but the idea that it is somehow fuelling a housing boom doesn't stack up in terms of the numbers."

 

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  • rate this
    +3

    Comment number 245.

    There are thousands of unemployed who are not counted on the official unemployment figures because they they do not qualify for Jobseekers' Allowance. This government is just a Think Tank with no clue how to administer its ideas in a professional manner. I do hope Labour gets its act together soon so we have a creditable alternative come 2015.

  • rate this
    +7

    Comment number 244.

    There is also the question of underemployment.

    As a Chartered Surveyor for the past 3 years I have really worked for 1½ days a week. As I do not receive any benefit I am therefore excluded from the unemployed total.

    There must be countless in my position so this probably would significantly increase the 2.51M stated by the ONS.

  • rate this
    +1

    Comment number 243.

    I'm by no means an expert, but I'm not sure I understand all these people saying savers are being hurt and they are earning nothing on their savings. Are you all saying your saving portfolio is 100% cash and bonds sitting in the UK? You should probably have a look into some diversification. It's the only free lunch as they say.

  • rate this
    +9

    Comment number 242.

    Bankers such as Mr Carney have been in the ascendency since the world economy fell foul to neoliberalism.
    We see the result, the worst ever economic crisis, worse than the 'Great Depression'
    Anyone taking a former Goldman Sachs executive seriously must be crazy, except of course, bankers and their vile associates.

  • rate this
    +3

    Comment number 241.

    I wonder...if we ever get below the 7% employment rate, will the proliferation of zero hour contracts have enabled it?
    If so, we will not be in a better place! More jobs, but no increase in wages!!

  • rate this
    +45

    Comment number 240.

    193.James T
    I am growing to despise how this country is run.
    __

    That's because it isn't 'run' in your interest.

    The only reason i can see for the lack of British rebellion against the outrages since the 2008 crash so far is the fear caused by the economic imprisonment that is 'the mortgage'.

  • rate this
    +58

    Comment number 239.

    The Bank of England is taking the wrong approach. As a general rule, controlling inflation should be of greater importance than controlling unemployment. Low inflation will help not hinder reductions in unemployment.

    And we can't keep interest rates at artificially low levels forever. They're already harming savers and may cause another unsustainable credit bubble if we're not careful.

  • rate this
    +3

    Comment number 238.

    This is a monetary policy for the super rich big business meaning they can borrow at low levels mid income groups small business will have higher borrowing costs & the poor have Wonga borrowing costs.Not a level infact a ski jump sized playing field. If we had a proper labour opposition they would give a committment to full employment & a mixed economy but we haven't so crony capitalism stays putt

  • rate this
    +3

    Comment number 237.

    At least it's not Gideon making this important decision.

  • rate this
    +89

    Comment number 236.

    To everyone who thinks this is about propping up the housing market, I think that is a smokescreen.

    The real motivation for this cap on interest rates is more worrying! The aim of keeping interest rates lower than inflation is so that the government can reduce the level of its debt.

    This is a tax on peoples savings, pensions and is a form of financial repression!

  • rate this
    -8

    Comment number 235.

    Those who criticise Carney's decision on the grounds that it's bad for the unemployed really do need to have their heads examined.

    By fixing on the unemployment figure rather than the number actually in employment, the Governor is making getting people back to work his priority. It's tough on savers, admittedly – but it's very positive for companies (big and small) that will create those jobs.

  • rate this
    +7

    Comment number 234.

    The more they persist with Zero interest policy. the more it will be impossible to get out. Everyone will be leveraged to the hilt for a tiny 3 bed house on London outskirts. When the economy does overheat, putting up interest rates will be like igniting the fuse of the whole gas network.

  • rate this
    +4

    Comment number 233.

    to all those suffering savers. Now you know just who this xxxxxx government supports apart from the bankers. Pull your hard won savings out of the UK and let it rot. good secure rates are available in the likes of Germany, Netherlands etc.

  • rate this
    +14

    Comment number 232.

    Keeping interest rates low makes commom sense by helping house owners & also buisnesses. However we do need to a long term committment to stay in Europe and also adopt a more German economic model if we are ever going to seriously become a strong nation again. Better employment relations, and abolish Zero hours contracts would be a start.

  • rate this
    +2

    Comment number 231.

    Assume therefore that they will cancel the monthly meetings until further notice?

    Might save a few pennies for George.

  • Comment number 230.

    This comment was removed because the moderators found it broke the house rules. Explain.

  • rate this
    +3

    Comment number 229.

    Keeping rates low so those of us with savings get nothing whilst those with borrowings get a great deal. Not that equitable really is it banks still make a good profit at our expense.

  • rate this
    0

    Comment number 228.

    So: those of us who need to get savings, who need to save more the lower the interest rate is if we are to keep up, won't be able to spend to stimulate the local economy and create jobs?

    Nice Catch-22 thinking, there.

  • rate this
    0

    Comment number 227.

    Well said MrBigBear (138) Newsrooms have much to answer for in these tough times. To be told, day after day, how poor we are does nothing for our beleaguered tourist industry, and what about the hours spent on reporting that Double Dip Recession we never had? Lighten up BBC etal and look for balanced reporting please.

  • rate this
    +1

    Comment number 226.

    The Bank of England is taking completely the wrong approach. Yes the economy is still relatively weak, but that's no excuse for prioritising control of unemployment over control of inflation. Controlling inflation will help not hinder reductions in unemplyment.

    And keeping interest rates artificially low may fuel another unsustainable credit bubble, and nobody wants that.

 

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