Carney Says BOE Ready to Ease If Market Rates Hurt

Bank of England Governor Mark Carney said officials are ready to add stimulus if investor expectations for higher interest rates undermine the recovery.

“The upward move in market expectations of where bank rate will head in future could, at the margin, feed into the effective financial conditions facing the real economy,” Carney said in a speech to business leaders in Nottingham, England today. “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.”

Carney introduced forward guidance this month to help the economic recovery, saying that policy makers plan to keep the benchmark interest rate at a record-low 0.5 percent for at least three years. Indications of strengthening U.K. growth and the U.S. Federal Reserve’s signals it may begin trimming its monthly purchases have prompted investors to raise bets that rates will rise sooner and push up gilt yields.

“Our forward guidance was clear that, although we would not reduce the stimulus until the recovery is secure, we would if necessary provide more,” Carney said. “We are focused on doing what we can to reduce uncertainty and build resilience so that the recovery can be sustained despite the inevitable shocks ahead.”

The pound pared its decline against the dollar after Carney spoke. It was at $1.5522 as of 3:35 p.m. London time, down 0.2 percent from yesterday.

Liquidity Rules

Carney’s comments today mark his first policy speech since he introduced guidance. He also announced that the BOE will relax liquidity rules on banks that meet capital requirements to help encourage lending and aid the economy.

While the recovery is showing signs of being “broad based and set to continue,” growth prospects “are solid not stellar,” he said. The BOE forecasts growth to average 2.5 percent a year over the next three years, compared with an historical average rate of 2.75 percent.

In addition, “a recovery in growth does not necessarily mean faster job creation and lower unemployment,” since a pickup in the U.K.’s “anemic” productivity growth could delay a drop in the jobless rate, he said.

Guidance Framework

Under the new guidance framework, the BOE plans to keep its benchmark rate unchanged until unemployment, currently 7.8 percent, reaches 7 percent. The BOE doesn’t see that happening until the end of 2016.

“We are giving confidence that interest rates won’t go up until jobs, incomes and spending are recovering at a sustainable pace,” he said. “Guidance provides you with certainty that interest rates will not rise too soon. Exactly how long they stay low will depend on the progress of the recovery.”

While Carney noted the increase in interest-rate expectations, he said this may be partly due to more optimistic forecasts for the jobless rate. BOE projections show just a 1-in-3 chance unemployment will drop to 7 percent by mid-2015. U.K. rate expectations also shouldn’t be guided by U.S. recovery prospects, according to Carney.

“The U.S. recovery is much further advanced,” he said. “While much has been made of the special relationship between the U.S. and U.K., it is not so special that the possibility of a reduction in the pace of additional stimulus in the U.S. warrants a current reduction in the degree of monetary stimulus in the U.K.”

Inflation Knockout

The BOE’s guidance includes so-called knockouts linked to its 2 percent inflation goal. Carney said underlying price pressure is “subdued” and inflation will fall back over the next two years from 2.8 percent.

“In these circumstances it would not makes sense to choke off the recovery by raising interest rates prematurely,” he said.

The BOE’s inflation mandate “has not changed,” and ‘I can also assure you of my personal commitment to price stability,’’ he said. “I certainly have no hesitation in raising interest rates when required.”

The central bank will use its “full suite of policy tools” to ensure a sustainable recovery, he said. That will include monitoring the housing market after some analysts said government measures to encourage demand may stoke a bubble.

“The Bank of England is acutely aware of the risk of unsustainable credit,” he said. “We are now fully prepared” to use so-called macroprudential tools to contain risks.

The BOE will also ease liquidity rules for lenders that meet capital targets. It will allow the main U.K. lenders to shrink their required holdings of low-yielding, easy-to-sell securities, such as government bonds, once they hold capital reserves equivalent to 7 percent of their risk-weighted assets.

“That will help to underpin the supply of credit, since every pound currently held in liquid assets is a pound that could be lent to the real economy,” Carney said. “Taken together, our actions create not just a more resilient system, but also one more able to support and sustain a recovery by serving the real economy.”

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