The Bank of England (BOE) intends to maintain its Bank Rate at the current level of 0.5 percent and is ready to purchase further assets at least until the U.K. unemployment rate falls to a threshold of 7.0 percent, the bank said as it adopted a form of forward guidance that sets out the conditions that may lead to a change in monetary policy.
But the BOE is also aware of the major challenges it faces with the UK's high inflation and low growth rates, and introduced two inflation conditions and a financial stability condition that would "knock out" the unemployment threshold.
Under the inflation conditions, consumer prices should remain below 2.5 percent in 1-1/2 to 2 years ahead and medium-term inflation expectations should remain anchored. Under the financial stability condition, the BOE's newly-created Financial Policy Committee must not consider the monetary policy stance a "significant threat to financial stability."
"The knock-outs would not necessarily trigger an increase in Bank Rate - they would instead be a prompt for the MPC to reconsider the appropriate stance of policy," Mark Carney, the new BOE governor said in his first policy initiative since moving from the Bank of Canada to the UK last month.
"But until the unemployment threshold is reached the MPC intends not to reduce the stock of asset purchases from the current 375 billion pounds," Carney added.
The two inflation knockouts were included by the BOE's policy-making body, the Monetary Policy Committee, to ensure that the forward guidance - known as a state-contingent guidance - is consistent with the BOE's primary objective of price stability, currently defined as inflation of 2.0 percent.
The financial stability knockout was included because the BOE, following the global financial crises, has been given responsibility for ensuring financial stability, with its Financial Policy Committee (FPC) created as an independent body within the BOE.
Forward guidance gives the BOE another tool in its strategy to help the U.K. economy recover from the financial crises along with its low bank rate - at 0.5 percent since March 2009 - asset purchases and the Funding for Lending Scheme.
"It is important to stress that forward guidance does not mean the MPC is promising to keep interest rates low for a particular period of time. The path of Bank Rate and asset purchases will, as always, depend on economic conditions," Carney said.
The UK's unemployment rate is currently at 7.8 percent, practically unchanged for the last 10 months, and Carney stressed that the BOE's bank rate would not automatically be increased when unemployment at some point drop to 7.0 percent, nor is that a target for unemployment.
"So 7% is merely a 'way station' at which the MPC will reassess the state of the economy, the progress of the economic recovery, and, in that context, the appropriate stance of monetary policy," he said.
In its latest inflation report, the BOE forecast that the unemployment rate would only drop to 7.3 percent at the end of the 3-year forecast period. The mean forecast for UK Gross Domestic Product is for expansion of 1.4 percent this year, up from May's forecast of 1.2 percent, 2.5 percent in 2014, up from 1.7 percent, and 2.3 percent in 2015, up from 1.9 percent.
The mean forecast is for inflation to reach 2.9 percent by the fourth quarter of this year, the same forecast as in May, then ease to 2.4 percent in Q4 2014, up from 2.1 percent, and then be 2.0 percent, up from 1.9 percent, by the fourth quarter of 2015.