THE Bank of England now expects UK unemployment to fall to the key 7% "threshold" much sooner than it projected in August, but has emphasised that reaching this level will not automatically trigger a rise in base rates.
In its latest quarterly inflation report, published yesterday, the Bank also lowered its forecasts for inflation and raised its projections for growth.
The Bank's Monetary Policy Committee (MPC) said in August that it did not intend to raise base rates from their record low of 0.5%, at which they have stood since March 2009, at least until the International Labour Organisation measure of unemployment had fallen to a "threshold" of 7%. It projected at the time that this would not happen until 2016.
Its forward guidance on rates would cease to hold if, in the MPC's view, it were more likely than not that annual UK consumer prices index inflation 18 to 24 months ahead would be 0.5 percentage points or more above the 2% target. It would also cease to apply if medium-term inflation expectations no longer remained sufficiently well-anchored.
In its latest inflation report, the Bank is projecting, if rates were to remain at 0.5% and the scale of its quantitative easing programme were held at £375 billion, ILO unemployment will fall to 7% around the end of 2014.
On the basis of market interest rate projections, that base rates start rising in 2015 and climb to 1% by the end of that year and to about 1.7% by the close of 2016, the Bank forecasts ILO unemployment will fall to 7% around the third quarter of 2015.
However, Bank of England Governor Mark Carney said: "One could imagine scenarios where the unemployment threshold is reached and...the best policy choice, policy option, for the MPC at that period of time is to keep rates at current levels because the trade-off between output and inflation is attractive."
Figures published yesterday by the Office for National Statistics showed the ILO unemployment rate was 7.6% in the July to September period.
Markit, which conducts the Chartered Institute of Purchasing and Supply's monthly surveys of UK manufacturing, services and construction activity, published research yesterday showing that 72% of households expect base rates to start rising in the next two years. This is up from 69% in October and 55% in August.
Jonathan Loynes, chief European economist at consultancy Capital Economics, said: "November's inflation report provided some superficial support for expectations that interest rates will rise sooner than the MPC suggested back in August. But we still think that the disinflationary effects of the spare capacity in the economy will keep rates on hold for longer than markets anticipate.
"As widely expected, the key development in the inflation report was the downward revision to the MPC's forecasts for the unemployment rate - the most important economic variable for monetary policy since the introduction of forward guidance back in August."
He added: "Admittedly, the markets never seemed to swallow the August (inflation) report projections and have consistently priced in the first hike in interest rates in 2015. In that respect, the MPC's new forecasts arguably just bring it more closely into line with current market thinking."
Mr Loynes believed Mr Carney had gone "out of his way" yesterday to emphasise again that the 7% threshold was merely a "way station" at which the MPC would reassess the stance of monetary policy and not an automatic trigger for a rate rise.
Highlighting the Bank's projection for inflation on the basis of base rates remaining at 0.5% throughout the forecast period, Mr Loynes said: "Even on the basis of unchanged policy, the latest CPI inflation forecast shows inflation still very close to its 2% target at the end of the three-year forecast period, long after unemployment is expected to hit 7%."
He added: "We retain the view that interest rates will remain on hold rather longer than the markets expect. However, we fear that Mr Carney and colleagues will have their work cut out to prevent market interest rates from rising further - with potentially adverse effects on the economic recovery - if unemployment remains on its recent downward trend."
Based on market interest rate expectations, the Bank has cut its projection of annual CPI inflation in the fourth quarter of 2013 from 2.9% to 2.2%, and reduced its forecast for the final three months of 2014 from 2.4% to 2.1%. It has cut its projection for the fourth quarter of 2015 from 2% to 1.9%.
Figures published on Tuesday by the Office for National Statistics showed annual CPI inflation tumbled from 2.7% in September to 2.2% in October - well below the City's 2.5% forecast.
The Bank cited sterling's recent strength as a factor in its reduced inflation forecasts. It raised its forecast of gross domestic product growth this year to about 1.5%, and that for 2014 to about 2.8%.
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