He said the Monetary Policy Committee (MPC) intends to keep Bank Rate at 0.5 per cent until the unemployment rate falls to 7 per cent; it is now 7.8 per cent. Although he said the path of unemployment is “highly uncertain”, the Bank believes there's a less than 50-50 chance of unemployment falling below 7 per cent before mid-2016. The Office for Budget Responsibility is more pessimistic; in March, it forecast that unemployment would stay above 7 per cent until 2017.
With the Bank expecting inflation to fall only gradually – to just under 1.9 per cent in 2016, this implies that we face at least another three years of negative real interest rates.
Dr Carney said that three factors could “knock out” this commitment to low interest rates: if the MPC envisages inflation above 2.5 per cent in 18-24 months’ time; if medium-term inflation expectations cease to be “well anchored; or if low rates pose a threat to financial stability. However, he warned that even these conditions “would not necessarily trigger and increase in Bank Rate”, and added that rates won’t automatically rise even if unemployment does fall below 7 per cent.
The Bank hopes that a commitment to low interest rates will reduce uncertainty and hence encourage investment. However, shares fell sharply on Dr Carney's remarks, corroborating fears that a commitment to low rates is a signal of a continued weak economy which might prevent firms investing. “Guidance could even backfire if certainty that rates in two years' time are likely to be as low as they are today simply defers purchases,” warned Neil Williams of Hermes Fund Managers.
Some economists, though, aren’t ruling out an early rate rise. James Knightley at ING, pointing to the experience of 1989 and 1997, says that unemployment can fall from 7.8 to 7 per cent within a few months if the economy picks up momentum. “Rate rises are more likely to start in early 2015 than late 2016,” he says. The market agrees with him: short sterling futures are pricing in a three-month Libor of 1 per cent by the autumn of 2015.
However, they don’t expect rates to rise much above 2 per cent until 2017, which implies four more years of negative real rates.
