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Bank of England ties low rates to unemployment target

  |   Aug. 7, 2013 at 9:19 AM
LONDON, Aug. 7 (UPI) -- The Bank of England said Wednesday that it would keep its 0.5 percent overnight interest rate in place until the unemployment rate dropped to 7 percent.

The pledge is similar to the U.S. Federal Reserve's stance that it will not raise interest rates until the unemployment rate reaches 6.5 percent unless it is forced to do so by high inflation.

The BOE made its announcement in its quarterly Inflation report, which was accompanied by a letter from the central bank's Governor Mark Carney.

Carney explained that the bank's pledge was contingent on "material risks" holding at acceptable levels, particularly inflation, which is already at 2.9 percent as of June.

Carney called the 7 percent pledge "merely a 'way station' at which the Monetary Policy committee will reassess the state of the economy, the progress of the economic recovery and, in that context, the appropriate stance of monetary policy."

The report said 6.5 percent would be considered a more "sustainable" unemployment rate and Carney spelled out several contingencies. "It is important to be clear that Bank Rate will not automatically be increased when the unemployment threshold is reached," he wrote.

The BOE expects that unemployment would remain higher than 7 percent for two years, although the recovery, Carney said, is gaining strength.

"A renewed recovery is now underway in the United Kingdom, and it appears to be broadening," Carney wrote.

The bank's decision-makers project the country's gross domestic product to reach 2.4 percent in two years, "a rate still a little below its historic average," Carney said.

With the lending rate at 0.5 percent, over the next three years, "the MPC's best collective judgment is that the median unemployment rate at the end of the projected period [of three years] is 7.3 percent.

Still, the historic changes include the bank announcing a pledge on policy that has traditionally been explained only after the fact.

"It is 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 is why the MPC is today 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," said Carney, who took over as bank Governor from Mervyn King in July.

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