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Economy: New Bank of England guidance underlines potential for interest rates to stay on hold

12:00 12 February 2014

Bank of England governor Mark Carney.

Bank of England governor Mark Carney.

The Bank of England said today that interest rates will remain on hold until the economy recovers further under new guidance designed to reassure households and businesses over the cost of borrowing.

In an additional “forward guidance” policy unveiled by the bank, it stressed that there remains “scope” to keep rates at the record low of 0.5%, adding that even when economic output returns to normal any future rises will be gradual and rates will be significantly below the 5% average seen before the financial crisis.

The bank’s quarterly inflation report signalled that markets expect rates to start to rise to 0.75% at the start of the second quarter next year, with inflation remaining at around the 2% target if borrowing costs rise as expected.

Bank governor Mark Carney insisted that forward guidance was working and said the next phase of the policy will reassure further over the path of rates.

He said: “If and when the time comes that the economy can sustain higher interest rates, Bank rate is expected to rise only gradually. For a sustained and balanced recovery, the degree of stimulus will need to remain exceptional for some time.”

Today’s quarterly report gave further good news on the economy as the bank revised up its forecast for output in 2014 to 3.4% from its previous estimate of 2.8%.

The bank said it expected growth figures for the fourth quarter of 2013 to be revised up from 0.7% to around 0.9%. It added that the recovery will remain robust in the current quarter, forecasting growth of around 0.8%.

Mr Carney said: “The recovery has gained momentum. Output is growing at the fastest rate since 2007, jobs are being created at the quickest pace since records began, and after four years above target the inflation rate is back at 2%.”

But the bank said there was spare capacity in the economy of around 1% to 1.5% of GDP, which means there is no rush for rates to rise.

The bank’s new pledge comes six months after it launched its first guidance policy assuring that rates would not rise until the rate of unemployment hits 7%.

Faster than expected falls in joblessness has meant the rate has already fallen to within a whisker of the target, at 7.1%, and the bank said today it believes official figures will show the threshold was reached in January.

Its new guidance, designed to provide further clarity once the current threshold has been hit, has ditched linking rates to specific targets, instead using a number of broad-based terms.

Mr Carney 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 MPC (Monetary Policy Committee) will not take risks with the recovery.”

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