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Bank of England Ties Interest Rate to Employment
The Bank of England said Wednesday that it planned to keep interest rates at a record low until unemployment falls to at least 7 percent, a significant shift in the bank's strategy to help Britain's economic recovery.
By linking future interest rate decisions directly to the unemployment rate, the Bank of England's new governor, Mark J. Carney, broke with tradition and aligned the bank more with the U.S. Federal Reserve's policy of giving more clarity about its intentions. Mario Draghi, the president of the European Central Bank, also recently eliminated some uncertainty by saying interest rates would not rise for some time.
After an initial drop against the dollar following Mr. Carney's announcement, the pound recovered and continued to strengthen, rising against the euro as well. The FTSE 100 share index fell slightly.
Short of pumping more money into economies that are still struggling to recover, central bankers in Europe have been seeking new ways to encourage banks to lend and trying to increase confidence among companies and consumers. Mr. Carney, who took over at the Bank of England last month, said the link with unemployment was aimed at reducing uncertainty.
The Bank of England said it did not plan to increase interest rates, currently at 0.5 percent, until the unemployment rate declined to at least 7 percent from the current level of 7.8 percent. The central bank also forecast that unemployment might not reach that level until at least the third quarter of 2016, hinting that interest rates in Britain could remain unchanged for another three years.
"The economy is in recovery rather than remission and this guidance gives the bank the flexibility to reduce the risk of relapse," Peter Spencer, an economic adviser at Ernst & Young's ITEM Club, said.
Giving such guidance "reduces uncertainty because there can be a premature view of withdrawal of stimulus as the recovery builds up," Mr. Carney said. "Our biggest concern is the possibility that as the recovery gathers pace that there is an unwarranted expectation of the pace of withdrawal of stimulus."
Mr. Carney noted that the unemployment rate benchmark should be seen as a "way station" at which the Bank of England would start to reassess its policy, not a target that would automatically trigger a change in interest rates. The Bank of England picked the unemployment rate, he said, because it sought a figure that was "widely understood and widely available."
Mr. Carney said the strategy, which he called "forward guidance," does not mean the Bank of England would abandon its main objective of lowering inflation to 2 percent. In a letter to the chancellor of the Exchequer, George Osborne, explaining the new strategy, Mr. Carney wrote that forward guidance "will further enhance the effectiveness of monetary policy so that it fully plays its part in securing a sustainable recovery over the medium term."
After closely avoiding a triple-dip recession earlier this year, the British economy has started to show some signs of improvement. Consumer confidence has recovered, the value of homes has increased and some economists have predicted that growth will gather speed over the rest of the year.
Mr. Carney cautioned, however, that while there was "understandable relief that the U.K. economy has begun growing again" there "should be little satisfaction."
"This is the slowest recovery in output on record," he said.
[Source: By Julia Werdigier, The New York Times, 07Aug13]
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