The Governor of the Bank of England has admitted that its new “forward guidance” on increasing interest rates will need to change because unemployment has fallen far faster than expected.
Mark Carney said it was time to “evolve” the guidance, raising the possibility the Bank may abandon the 7pc unemployment trigger to consider an increase in rates.
On Tuesday, it was revealed that the unemployment rate had already fallen to 7.1pc, reports The Telegraph.
The Governor made it clear that even with falling unemployment, the UK’s economic recovery had yet to reach “escape velocity” and that interest rates are likely to remain at historic lows.
“Unemployment seems to be falling at a pace that will reach our 7pc threshold materially earlier than we had expected,” Mr Carney said at the World Economic Forum in Davos.
“It is widely recognised that our 7pc threshold is not a trigger for raising [the] bank rate . . . it is merely the point at which the MPC [Monetary Policy Committee] begins to even think about adjusting policy.”
He suggested that even if it is not changed, the figure is not seen as important as it initially was in deciding whether interest rates would rise. The Governor has said previously that the Bank will consider other indicators.
“Last August, the MPC said that when the threshold was reached, there should be no assumption of an immediate, automatic change to its policy stance,” he said.
“It would assess the prevailing economic conditions, including wider measures of slack and inflationary pressures, before deciding the appropriate stance for monetary policy.
“The Bank’s assessment of how to evolve guidance to changing circumstances will begin in our February Inflation Report.
“The MPC will consider a range of options to update our guidance, recognising both what we have learned about the behaviour of aggregate supply in the economy as well as the more benign inflation outlook.”
Mr Carney said that although economic growth was welcome there were still a number of “headwinds” which were threatening the recovery.
He said that productivity growth had slowed, that the debt burden was still high and that consumer confidence was “subdued”. Low inflation also meant that raising interest rates became less urgent even though the economy is growing.
Although business investment was starting to increase, Mr Carney argued that many companies were still retaining capital.
“A few quarters of above-trend growth driven by household spending represent a good start, but they aren’t sufficient,” he said.
“These persistent headwinds mean that, even in the medium term, the level of interest rates necessary to sustain low unemployment and price stability will be somewhat lower than before the crisis.
“In the jargon, the equilibrium real interest rate, which has been negative for much of the period since the crisis, will eventually turn positive again, but it is likely to remain well below historical norms.”
Mr Carney said that global economies were still operating below their pre-crisis levels, although he said he was aware of the risks of maintaining ultra-loose monetary policy, particularly for the housing market.
The Governor said that a lot had been done to reform banking and that the City was a “national asset” for Britain.
“The UK financial system is both a global good – it supports an open global system – and a national asset.
“To realise its potential, we need our system to be safe, fair and to act with integrity. Without those foundations, the innovation for which finance in the UK is renowned will be meaningless.
“Much has been achieved in recent years to repair the core of the banking system.
“It is not the Bank of England’s role to champion the City. By making it safer and fairer we can put in place the conditions for it to thrive.”
