Bank of England provides forward guidance

The Bank of England’s MPC (Monetary Policy Committee) voted to provide some clearly defined guidance on its future conduct of monetary policy for the first time.

The Bank of England says its lending rate and easing program will depend on the country’s unemployment rate.

The MPC explained that its “current highly stimulative stance of monetary policy” will be at least maintained until the economic slack has been significantly reduced, “provided this does not entail material risks to either price stability or financial stability”.

The MPC stressed that the current Bank Rate of 0.5% will not rise until the Labor Force Survey headline measure of unemployment has dropped to a maximum of 7% (subject to conditions listed further down this page).

Most experts do not expect the unemployment threshold to drop below 7% until 2016.

While the unemployment rate remains above 7%, the MPC says it will carry on with the asset-purchase program, i.e. injecting cash into the economy, which currently stands at £375 billion ($571 billion, €431 billion).

The MPC added “But until the unemployment threshold is reached, and subject to the conditions below, the MPC intends not to reduce the stock of asset purchases financed by the issuance of central bank reserves and, consistent with that, intends to reinvest the cash flows associated with all maturing gilts held in the Asset Purchase Facility.”

Tying the Bank Rate and injecting money into the economy to the unemployment threshold would cease to hold if any of the three situations listed below occurred, the MCP said:

  • Inflation, in the MPC’s view, during the coming 18 to 24 months will “more likely than not” exceed 2.5%
  • Inflation expectations over the medium term are no longer sufficiently well anchored
  • “The Financial Policy Committee (FPC) judges that the stance of monetary policy poses a significant threat to financial stability that cannot be contained by the substantial range of mitigating policy actions available to the FPC, the Financial Conduct Authority and the Prudential Regulation Authority in a way consistent with their objectives.”

The Governor of the Bank of England, Mark Carney, says the new forward guidance will help the loose monetary policy be effective for the following reasons:

  • There will be less uncertainty about the future
  • Market interest rates are less likely to rise precipitately
  • The tradeoff between inflation and employment is clearly defined
  • It makes it more feasible for policy makers to achieve sustainable employment levels without undermining financial stability

Last week the MPC voted to keep the Bank Rate at 0.5%.

Signs have emerged of a broader recovery in the British economy. The Bank of England raised its median forecast for 2013 GDP (gross domestic product) growth from 1.2% to 1.4%. The Bank of England now forecasts GDP will grow by 2.6% in 2014; it had previously predicted 1.8% growth. The forecast for 2015 has risen to 2.3% from 2%.

What is forward guidance?

”Forward guidance” means making a pledge about the future, especially future interest rates.

Central banks directly control the short-term interest rate at which it lends to or borrows from commercial banks overnight. The Bank of England MPC meets every month and sets the interest rate.

In its forward guidance, the bank has announced that it aims to hold the 0.5% interest rate until inflation drops below 7%.

Mr. Carney added that when the 7% unemployment threshold is met, interest rates will not necessarily rise automatically. He described that point as a “waystation” when the MPC will further consider the issue.

In a news conference today, Mr. Carney said:

“A renewed recovery is now underway in the United Kingdom, and it appears to be broadening. Well, that is certainly welcome. The legacy of the financial crisis means that the recovery remains weak by historical standards, and there’s still a significant margin of spare capacity in the economy. This is more clearly evident in the high rate of unemployment.

It’s now more important than ever for the Monetary Policy Committee to be clear and transparent about how it will set monetary policy in order to avoid an unwarranted tightening in interest rate expectations as the recovery gathers strength. That’s why today, the MPC is announcing explicit state-contingent forward guidance. Our aim is to help secure the recovery, while ensuring that risks to price stability and financial stability are well contained.”

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