Feb. 12 (Bloomberg) -- Bank of England Governor Mark Carney underscored his pledge to keep interest rates at a record low in a recasting of forward guidance to combat persisting slack in the British economy.
“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,” Carney said in London as he published the central bank’s quarterly Inflation Report. “As guidance evolves, that remains the case: the Monetary Policy Committee will not take risks with the recovery.”
The BOE raised its growth forecasts today, prompting investors to increase bets for higher rates even as Carney tries to reassure Britons that borrowing costs will stay at 0.5 percent for some time. Other central banks including the Federal Reserve are also refining their forward guidance as they try to secure sustainable recoveries for their economies.
The BOE now reckons that unemployment fell to the 7 percent threshold for its original guidance in the quarter through January. In the Inflation Report, BOE officials also estimated an output gap at 1 percent to 1.5 percent of gross domestic product as they provided more detail on the factors that will influence their decisions.
The MPC “is for the first time today providing guidance that it is seeking to absorb all the spare capacity in the economy over the next two to three years,” Carney said. “That recognizes that spare capacity is both wasteful and increases the risk that inflation will undershoot the target” of 2 percent.
Carney set the 7 percent jobless level to consider an interest-rate increase when he introduced guidance in August. While unemployment has fallen faster than officials expected, prompting questions about the policy’s credibility, the BOE is maintaining its push to convince households and businesses that higher interest rates are still some way off.
Fine-tuning guidance isn’t unique to the BOE. The Fed, now led by Chairman Janet Yellen, hedged the labor-market threshold in its guidance in December, saying that the benchmark lending rate is likely to remain around zero “well past the time that the unemployment rate declines below 6.5 percent.” Fed Bank of Atlanta President Dennis Lockhart said this month they may even reduce that marker. European Central Bank President Mario Draghi last month strengthened a pledge to keep rates low for as long as necessary.
In its report, the BOE said it expects fourth-quarter GDP growth will be revised up to 0.9 percent from the 0.7 percent estimated by the statistics office. It forecast a similar pace of expansion this quarter. For the full-year 2014, it raised its projection to 3.4 percent from 2.8 percent in November.
The pound strengthened after the bank released its forecasts. It was up 0.4 percent at $1.6517 as of 12:44 p.m. in London. Short-sterling futures contracts fell, indicating traders are adding to bets for higher rates. The implied yield on the contract expiring in December climbed 4 basis points to 0.76 percent, with the March 2015 contract up 6 basis points at 0.93 percent.
While the BOE offered an upbeat outlook, saying it expects the recovery to become “more entrenched and more broadly based,” it added that any rate increases are likely to be gradual.
“We are serene about where the stance of monetary policy should be,” Carney said. “Serene but not complacent.”
The MPC also offered borrowers further comfort about rates as the economy strengthens, saying they are unlikely to rise as high as they did before the financial crisis struck.
“The legacy of the financial crisis and the persistence of economic headwinds mean that interest rates may need to remain at lower levels for some time to come,” the BOE said. “Even when the economy has returned to normal levels of capacity and inflation is close to the target, the appropriate level of bank rate is likely to be materially below the 5 percent level set on average by the committee prior to the financial crisis.”
On inflation, the BOE lowered its projections throughout the forecast period, reflecting smaller-than-expected increases in utility prices and a stronger pound. Sterling has risen about 6.5 percent against the dollar in the past six months.
Based on investors’ expectations for interest rates, with the first increase seen coming in April 2015, the central bank sees inflation at 1.9 percent in three years, below its goal.
“The inflation environment is more benign than we had anticipated,” Carney told reporters, citing subdued global prices, falling commodity costs and a strengthening of the pound. “All of these developments will hold back imported inflation pressures that have to a great extent explained the above-target inflation over the past five years.”
The BOE sees inflation slowing to as low as 1.7 percent in the second quarter of 2015, based on market interest-rate expectations. It will gradually accelerate after that, reaching 1.9 percent in 2016 and staying around that level.
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