The Bank of England (BoE) has indicated that it will maintain the benchmark UK interest rate, which next month will have been at a record low of 0.5% for five years, to be maintained for at least a further year, despite forecasts that Britain’s economic growth will continue to strengthen in 2014.
BoE governor, Mark Carney, said that the recovery is “as yet is neither balanced nor sustainable,” as he delivered its quarterly inflation report.
“Activity is still below its pre-crisis level and the household saving rate is likely to fall further,” he added and the BoE “will not take risks with this recovery”.
After taking up the BoE post last July, Carney announced a ‘forward guidance’ strategy, under which the BoE would consider a rate rise only when the unemployment rate, which then stood at 7.8%, fell to 7%. At that time, projections suggested that it would not be until 2016 until the threshold was reached. However, the BoE’s interest rate-setting monetary policy committee (MPC) now believes that the rate, which fell to 7.1% in December 2013, dropped again last month to 7%.
Nonetheless, Carney said that with hindsight the MPC would still have provided a specific unemployment threshold, even though it is set to be breached less than six months after it was set.
He added that “forward guidance is working”, as uncertainty over interest rates had lessened and “most importantly, businesses have understood the guidance”, with a BoE survey suggesting that three in four UK firms believe it has boosted their confidence.
The BoE has also revised its UK economic growth forecast for 2014 to 3.4% from its November forecast of 2.8%. The new figure is significantly higher than that predicted by the International Monetary Fund (IMF), which last month penciled in a figure of 2.4%. For 2015 and 2016, the BoE predicts growth of 2.7% and 2.8% respectively.
Despite this, a combination of weakening inflationary pressure, spare capacity, and ‘headwinds’ at home and abroad, meant that “bank rate may need to remain at low levels for some time to come”. The MPC also indicated that when the interest rate does eventually rise it will do so gradually and probably edge no higher than 2%-3%.
Seeking to reassure businesses and households, the Bank’s monetary policy committee said that when rates did eventually go up, they would do so only gradually, settling around 2-3%. By comparison, in July 2007, just before the global financial crisis got underway, the MPC raised the rate from 5.50% to 5.75%.
“Raising bank rate gradually would guard against the risk that, after a prolonged period of exceptionally low interest rates, increases in Bank rate have a bigger impact than expected on output and spending,” the report stated.
Elsewhere in the report the BoE makes clear that it anticipates a sharp rise in both UK business and housing investment, of 11.5% and 23% respectively, this year.
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