The Bank of England has pledged to keep rates at their lowest level in its 300-year history until unemployment falls to 7 per cent, hoping the commitment will help nurture the nascent recovery in the world’s sixth biggest economy.

Marking a significant shift in strategy by the central bank under new governor Mark Carney, the BoE on Wednesday provided more explicit guidance to markets and the publc that monetary policy would remain loose until the economy returned to better health.

He told his first press conference since he started the job that Britain’s economy was recovering but was still too weak. “This remains the slowest recovery in output on record,” he said. “We’re not at escape velocity right now.”

But the MPC said it would rethink its guidance if inflation was set to be 2.5 per cent or higher in the medium-term, if inflation expectations were out of control, or if the policy was threatening financial stability.

Markets gyrated as investors tried to digest the new policy. Sterling, which initially fell 0.9 per cent to $1.5207, subsequently gained more than 3 cents to stand 1.1 per cent higher at $1.5512 against the dollar as forex traders bet against the Bank being able to hold off from interest rate increases until mid 2016.

Equity investors appeared to remain unconvinced the economy could gather momentum without further support and the FTSE 100 fell 1.4 per cent to 6,511.21. The yield on the 10-year Gilt, which moves inversely to the price, rose 0.1 basis points to 2.48 per cent.

“The markets’ view of the MPC’s guidance seems to be that although it might have clarified some aspects of the policy outlook, it is also relatively ‘soft’ because the accompanying provisos give plenty of room for policy to deviate from the indicated path,” said Simon Hayes, an economist at Barclays. “In our view, the markets’ interpretation is right.”

Mr Carney maintained that the BoE’s commitment to its inflation target was “unwavering”. Guidance was, he said, “first and foremost” about making the monetary stimulus more effective and lessening anxiety that the MPC would tighten interest rates.

Sir John Gieve, a former BoE deputy governor, said: “It’s not really a change of policy, but a change of policy explanation.”

However, some economists said the BoE’s three “get-out clauses” made the guidance less robust and harder for the public to understand. “This is not a message to the man on the street given its potential complexity,” said George Buckley, an economist at Deutsche Bank.

Charles Goodhart, a former member of the Monetary Policy Committee, said the “great question” was now the speed at which unemployment would fall. “The answer to which is that nobody knows.”

Philip Rush, an economist at Nomura, said investors would have to study the unemployment data for clues as to the path of monetary policy. “Every month of strong employment growth now carries the potential for market rate expectations to get pulled forward,” he said. “And that is before considering any of the three ways that guidance might be exited early.”

Mr Carney stressed the 7 per cent unemployment rate was not a target, but a “way-station” on the path to full recovery.

Guidance also “provides a framework to test how much excess supply there is in an economy”, he said.

What Mr Carney said ... and what he might have meant

“We’re not at escape velocity right now.”
Mr Carney thinks there is still plenty of “spare capacity” in the economy. He does not want investors, businesses and households to get carried away and assume the Bank of England will withdraw economic stimulus any time soon.

“The path of market interest rates implies a faster withdrawal of monetary stimulus than appears likely given the current economic outlook.”
Mr Carney thinks markets have already got it wrong. On Wednesday, sterling climbed as investors bet on the BoE responding to inflationary pressures before unemployment hits 7 per cent.

“7 per cent is merely a ‘way station’ at which the MPC will reassess the state of the economy, the progress of the economic recovery, and, in that context, the appropriate stance of monetary policy.”
Mr Carney does not want to imply the Bank of England will raise rates as soon as the unemployment rate reaches 7 per cent. Nor does he want to suggest that is an acceptable unemployment rate in the long-term.

“It is important to stress that forward guidance does not mean the MPC is promising to keep interest rates low for a particular period of time. The path of Bank Rate and asset purchases will, as always, depend on economic conditions.”
Mr Carney does not want to tie his hands. The new guidance policy has plenty of “get out” clauses if the economy starts to behave differently to the way the central bank expects.

“We have to put recent developments in the housing market in context, we still see mortgage applications are well below historic averages.”
While Mr Carney says he is watching the housing market carefully, he does not seem to agree with those who warn the government’s “Help to Buy” mortgage guarantee programme is inflating a house price bubble.