The new governor of the Bank of England, Mark Carney, has signalled that Britain's ultra-low interest rates would remain unchanged until well after the 2015 general election as he stressed that only a big fall in unemployment would bring an end to the cheap money of the past four years.
In a move welcomed by George Osborne as likely to support the UK recovery from its deepest recession in recent history, Carney said he would wait until the jobless rate lowered to 7% before considering whether to push up the cost of borrowing.
The governor said the Bank would only think again about its pro-growth stance if there was a threat of higher inflation or asset bubbles, but the City said the chances of the government's election plans being disrupted by a tightening of monetary policy were remote.
Carney said there was "understandable relief" that the economy had started to grow again and that the Bank's monetary policy committee wanted to reassure households and businesses that there would be no early increase in interest rates from their record low of 0.5%, or any unwinding of the £375bn stimulus provided by the quantitative easing programme.
"There are clear signs that economic activity has strengthened this year," Carney said. "But there should be little satisfaction. Much is at stake as we seek to secure this recovery and return inflation to target."
The unemployment rate – currently 7.8% – was the biggest sign that the UK still needs help, Carney said. "Until the margin of slack within the economy has narrowed significantly, it will be appropriate to maintain the current exceptionally stimulative stance of monetary policy."
He added that to hit the 7% threshold for unemployment, the economy would need to create 750,000 new jobs. The Bank thinks this is unlikely before 2016.
Osborne is confident that the aggressive action by the Bank will offset the impact of his austerity measures and ensure that the economy is growing steadily by the time of the election in the spring of 2015. Weak growth in wages and below-inflation increases in benefits are seen as threats to consumer spending this year.
Ed Balls, the shadow chancellor, welcomed the so-called "forward guidance" from the Bank but said Osborne also needed to act to support the economy.
"By recognising the importance of policy action to support jobs and growth, at last we are seeing the governor show the leadership we have failed to see over the last three years and are still not seeing from the chancellor. Mark Carney is right to warn that the recovery is weak. It is the slowest on record and families are facing a growing cost of living crisis.
"But the new governor is not a miracle worker and monetary policy cannot do the job alone. As we and the International Monetary Fund have consistently said George Osborne must finally act to support the economy and also help families feeling the squeeze." Carney insisted that the Bank had not abandoned its commitment to low inflation and said there were three circumstances in which it would re-think its pledge to keep policy loose. These were a forecast that the annual increase in the cost of living would be more than 2.5% 18-24 months in the future; signs that the public was beginning to take higher inflation for granted; and a risk of rapidly rising asset prices that could not be tackled other than by raising the cost of borrowing.
Carney said that the Bank's guidance would cease to apply if any of these "knockout clauses" were triggered, and this helped the pound to weather an initial sell-off and end the day a cent higher against the US dollar at $1.55. Before the announcement, dealers felt a rate rise was unlikely until late 2015 but some now believe an earlier tightening of policy is possible. The FTSE 100 Index closed at its lowest level in a month, dropping 93 points to 6511.
Both sides of industry welcomed the Bank's decision. Frances O'Grady, general secretary of the TUC, said: "Today's announcement shows that the Bank understands a real recovery is something that benefits ordinary people, and not just an upward blip in economists' outlooks."
John Allan, national chairman, Federation of Small Businesses, hailed "a profound shift in monetary policy" and added: "We welcome this bold and imaginative thinking to secure the recovery. In the longer term, we hope it will give investors and firms looking to grow confidence to bring forward work which will in turn help increase employment."
Peter Spencer, economic adviser to the Ernst & Young ITEM club, said: "The hype surrounding Mark Carney did not go in vain as he managed to deliver on high expectations of shaking up the UK's monetary policy approach. The economy is in recovery rather than remission and this guidance gives the Bank the flexibility to reduce the risk of relapse."
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