The Governor of the Bank of England, Mark Carney, yesterday warned financial markets not to doubt the sincerity of his pledge to keep interest rates at rock bottom until 2016 in order to support the recovery.
Since the Bank of England unveiled its historic "forward guidance" pledge on rates earlier this month, traders have defied Threadneedle Street by bringing forward their estimate of when the first rise in the Bank rate will occur to the middle of 2015, effectively tightening financial conditions across the economy. But, delivering his first speech as Governor in Nottingham, Mr Carney said that if markets continued to tighten in this way the Bank would be prepared to enact more monetary stimulus.
"If they tighten, and the recovery seems to be falling short of the strong growth we need, we will consider carefully whether, and how best, to stimulate the recovery further," he said.
The Governor refused to specify what particular measures would be considered, but they would be likely to include a restarting of the £375bn quantitative easing programme.
However, despite the Governor's warning, markets failed to push back their expected date for the first Bank rate increase. Sterling, after initially dropping, also ended higher against the dollar, belying Mr Carney's dovish message on rates.
On 7 August the Bank of England's Monetary Policy Committee pledged that it would keep interest rates at 0.5 per cent until the unemployment rate falls from its present level of 7.8 per cent to at least 7 per cent, something it does not anticipate taking place until the second half of 2016. This guidance would cease to hold if inflation expectations rose, or if there was a threat to financial stability.
The Governor yesterday conceded that one of the reasons financial markets might be pricing in an earlier rise in policy rates is that traders think the unemployment rate will fall to the 7 per cent target more quickly than the Bank. Mr Carney said that, while hitting the jobless target early would be welcome, "policy is built not on hope, but expectation".
He added that there was only a one in three chance of the 7 per cent target being hit in mid 2015, when markets are currently pricing in the first rate rise.
The Bank believes the UK's productivity – output per hour worked – will gradually pick up as the economy returns to growth, limiting the pace of job creation over the next three years.
Mr Carney noted that the level of UK productivity is today no higher than it was in 2005 – and in a reference to the Nottingham-born singer-songwriter he added that this was "before Jake Bugg got his first guitar".
Cementing his dovish message on rates, the Governor reiterated that the 7 per cent target was merely a "staging post" and that reaching it would not result in an automatic rise in rates.
Mr Carney downplayed fears that the UK is witnessing the beginning of a new housing market bubble, pumped up by the Chancellor's home-buying mortgage subsidies.
However, he added that the Bank "is acutely aware of the risk of unsustainable credit and house-price growth and will be monitoring it closely".
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