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Bank Of England Pledges Low Interest Rate; Signals Hike In 2015


The Bank of England on Wednesday hinted that the interest rates are unlikely to rise anytime soon even as the unemployment rate fell faster than it estimated in August.

In the quarterly Inflation Report, released Wednesday, the BoE's Monetary Policy Committee suggested that the interest rate is set to rise only in the second quarter of 2015, in line with current market expectations. The bank estimates that the unemployment rate has fallen to the 7 percent threshold in January this year.

Earlier in August 2013, the bank has pledged not to hike interest rate until the jobless rate hit 7 percent. Today the bank widened the elements of its forward guidance and assured markets that interest rates will not be raised as it risks recovery.

The MPC judged that there remains scope to absorb slack further before raising the Bank Rate. Moreover, the continuation of significant headwinds, both at home and from abroad, mean that the interest rate may need to remain at low levels for some time to come.

In assessing the strength of the economy, the bank said it will monitor a broad range of indicators including unemployment, labor productivity and wages.

Governor Mark Carney said, "Forward guidance is working." Expected interest rates have remained low even as the economy has recovered strongly and uncertainty about interest rates has fallen, he added.

"And most importantly, UK businesses have understood the message," the BoE chief told reporters.

Any increase in the bank rate should be limited and gradual, Carney said. For a sustained recovery, stimulus should to be exceptional for some time, he said. Further, the quantitative easing of GBP 375 billion will remain intact until rates rise, the policymaker asserted.

This "second phase" of guidance obviously lacks the simplicity of the previous one, said Jonathan Loynes, chief European economist at Capital Economics. Perhaps the main effect of the changes to forward guidance will be to shift the focus back on the outlook for inflation, the economist noted.

"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.

"As guidance evolves, that remains the case: the MPC will not take risks with the recovery."

Further, Carney said the interest rate is unlikely to reach pre-recession levels around 5 percent.

"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," the BoE chief said.

Further, the bank forecasts inflation to remain close to the 2 percent target over the forecast period. The bank today lifted the 2014 GDP growth outlook to 3.4 percent from 2.8 percent. The central bank estimates an output gap of 1 percent to 1.5 percent of GDP at present.

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