In his first big speech since taking charge in July, Carney left the door open for fresh stimulus measures if adverse market reaction to the Bank’s new forward guidance regime threatened the UK’s “fledgling recovery”.
The governor said he was trying to provide certainty to businesses and households that the recent signs of growth would not be followed swiftly by a tightening of policy.
“We have a recovery that’s just beginning. It’s a very long way back. We are lagging just about everybody else in the advanced world. There’s a lot of spare capacity”, Carney said in a press conference following his speech to business leaders in Nottingham.
The City was left unimpressed by the renewed commitment to leave interest rates at their record low of 0.5% and to maintain the level of assets purchased under the Bank’s quantitative easing programme at £375bn. Sterling jumped by half a cent against the dollar after he spoke, while yields on 10 year gilts rose from 2.73% before his speech, to 2.8% afterwards – the opposite direction to the move Carney might have hoped for.
Traders believe that the pick-up in economic activity will strengthen over the coming months and that the unemployment rate will fall to 7% – the threshold at which Carney might raise interest rates – well before the 2016 date pencilled in by the Bank.
The governor’s announcement on Wednesday that banks would be able to reduce their holdings of liquid assets by £90bn, thereby making it easier for them to lend, strengthened the belief that Threadneedle Street was being too pessimistic about growth prospects.
But Carney insisted that the 7% jobless rate was a “staging post”, which would not necessarily lead to borrowing costs going up but only require the nine-strong monetary policy committee to re-think its approach. The jobless rate stands at 7.8% currently.
He said the Bank’s task was “to secure the fledgling recovery, to allow it to develop into a period of sustained and robust growth. We aim to get there in part by reducing the uncertainty that has held back growth.”
Since the MPC adopted its new policy of forward guidance in July, investors have brought forward their expectations of a rate rise, amid strong economic data for the UK, and fears about the knock-on effects if the US Federal Reserve phases out its own $85bn(£55bn)-a-month programme of QE.
But the new governor insisted the Bank will not be swayed by decisions made thousands of miles away in Washington.
“While much has been made of the special relationship between the US and UK, it is not so special that the possibility of a reduction in the pace of additional stimulus in the US warrants a current reduction in the degree of monetary stimulus in the UK,” he said.
City analysts said, however, that the speech lacked details of how exactly Carney and his colleagues will respond if the current market reaction persists.
“If market rates are at ‘unwarranted’ levels and rise further, putting recovery in the real economy at risk, what would the BoE do?”, said Ross Walker, UK economist at Royal Bank of Scotland.
Simon Wells, of HSBC, said: “There was little attempt to talk the market down with threats of imminent easing. Even if Mr Carney is personally irritated or concerned by the rise in market rates, he probably knows that there is little chance of garnering a majority on the MPC for policy loosening at this stage”.
Carney did explain how he plans to use the Bank’s new powers to supervise Britain’s banks, in order to underpin recovery. He confirmed that once individual banks have increased their capital levels to the new minimum level of 7% of their risk-weighted assets, the Prudential Regulatory Authority will relax liquidity rules, allowing them to hold less of their capital in the form of the most liquid instruments such as government bonds. In total, the Bank says the move could free up £90bn for new lending.
The governor also addressed fears that the government’s various schemes to rekindle the housing market, coupled with the Bank’s promise to keep rates low, risked stoking a new speculative bubble. He said there was little evidence of a boom, with mortgage approvals running at just over half their pre-crisis level, and debt servicing costs low.
But he added that the Bank was “acutely aware of the risk of unsustainable credit and house price growth and will be monitoring it closely”.