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Bank of England remains committed to 0.5% rate

THE Monetary Policy Committee has signalled it is in no hurry to raise UK base rates, in spite of an unexpectedly sharp tumble in unemployment, and emphasised future increases in the benchmark borrowing cost are likely to be gradual.

This dovish message from the Bank of England committee is contained in the minutes of the MPC's January 8 and 9 meeting, which were published yesterday.

Publication of the minutes coincided with the latest labour market figures from the Office for National Statistics. These showed that UK unemployment, on the International Labour Organisation measure, had fallen to 7.1% in the September to November period.

The MPC said last August it did not intend to raise UK base rates from their record low of 0.5%, at which they have stood since March 2009, at least until the ILO measure of unemployment had fallen to a "threshold" of 7%.

This 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 were no longer sufficiently well-anchored.

The MPC, chaired by Bank of England Governor Mark Carney, appeared at pains at its meeting two weeks ago to emphasise that a fall in unemployment to 7% in the near term would not necessarily trigger a rise in rates.

The minutes signal MPC members have taken comfort from the fall in annual CPI inflation to the 2% target in December. This was the first time since November 2009 that inflation had not been above the target, set for the MPC by the Treasury.

MPC members also noted continued weakness in pay growth, and the fact that Bank of England staff had revised down their estimates of the impact of rises in utility prices on inflation.

Headwinds for UK economic recovery were also discussed by MPC members, who also noted the degree to which growth so far had been driven by consumer spending and raised questions over the sustainability of this situation.

The minutes highlight a view among MPC members two weeks ago that the ILO unemployment rate was likely to reach the 7% threshold "materially earlier than previously had been expected".

MPC members noted that, while the recovery was becoming more firmly entrenched, productivity growth had been disappointing, and unemployment had fallen faster than expected.

However, signalling MPC members are in no rush to raise rates, the minutes state: "Inflation had returned to the 2% target...and cost pressures were subdued. Members therefore saw no immediate need to raise Bank Rate even if the 7% unemployment threshold were to be reached in the near future."

Emphasising rates were unlikely to climb sharply when the time came to increase them, the minutes add: "It was likely that the headwinds to growth associated with the aftermath of the financial crisis would persist for some time yet and that inflationary pressures would remain contained. Consequently, when the time did come to raise Bank Rate, it would be appropriate to do so only gradually."

MPC members believed a higher rate of return to work by people who had been long-term unemployed suggested slack in the labour market might not have been eroded as much as the fall in headline unemployment appeared to imply.

External MPC member Ian McCafferty told Nottingham Business School yesterday: "Alongside the recovery in the economy and that fall in unemployment, we have also seen a reduction in the rate of inflation, to 2%, and cost pressures remain subdued.

"It is therefore worth re-stating that the 7% unemployment level is only a threshold, not a trigger, and that the MPC sees no immediate need to increase interest rates even if 7% were to be hit in the near future."

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