Bank of England signals 'scope' to keep rates low under new guidance

Mark Carney hints at rate hike in 2015; upgrades growth forecast for UK economy

Mark Carney; '[there is] no immediate need to increase interest rates' (Stefan Rousseau/Pool/Reuters)

Bank of England Governor Mark Carney was forced to overhaul his six-month-old forward guidance policy today as Threadneedle Street switched aim to take up more slack in the economy before raising interest rates.

The Bank has been surprised by how rapidly unemployment has fallen to within a whisker of the 7 per cent threshold at which rate rises could be considered.

Carney — who insisted forward guidance “is working” amid hostile questioning — published the Bank’s estimate of the so-called “output gap” of slack in the economy for the first time, putting it at between 1 per cent and 1.5 per cent of GDP.

The Bank’s “evolved” guidance insists that rate-setters will target soaking up all the “wasteful” spare capacity in the economy over the next three years. There is scope for more slack to be taken in before interest rates are raised, the Bank adds.

Interest rates will only rise “gradually” and the Bank will monitor a range of indicators such as labour force participation and surveys of spare capacity in the economy. Rate rises will also be limited — potentially standing at 2 per cent only three years from now, Carney added.

He stressed, however, that the recovery was “ neither balanced or sustainable” as yet and said: “The first phase of guidance gave businesses confidence that 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 Bank noted that markets expect the first rate hike in April 2015, the month before the general election. Unlike last summer, the Bank did not go out of its way to say this expectation is “unwarranted”.

The original 7 per cent unemployment threshold, set last summer, should be met in the first three months of this year. The economic backdrop has strongly improved with the UK last year posting the strongest growth since 2007. Inflation has hit the monetary policy committee’s 2 per cent target for the first time in more than four years.

The Bank revised its growth forecast up dramatically to 3.4 per cent for this year and inflation is set to fall to 1.9 per cent at the end of this year.