POLITICS

Unemployment Link To Interest Rate Rises Could Put Firms Off Hiring, Experts Warn

07/08/2013 13:07 BST | Updated 07/08/2013 13:45 BST
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Mark Carney, governor of the Bank of England, arrives to attend the bank's quarterly inflation report news conference at the Bank of England in London, U.K., on Wednesday, Aug. 7, 2013. The Bank of England for the first time linked the outlook for its benchmark interest rate to unemployment and inflation and will keep its current policy 'at least' until the jobless rate falls to 7 percent. Photographer: Simon Dawson/Bloomberg via Getty Images

Bank of England governor Mark Carney's 'forward guidance' policy to keep interest rates low at 0.5% until unemployment falls below 7% could put businesses off hiring extra staff, economic analysts have warned.

Speaking to the Huffington Post UK, Michael Jarman, head of equity strategy at H20 Markets, said: "'Carney's forward guidance is a great move but I'm not a fan of [linking it to] the unemployment rate.

"Unemployment will come down naturally if businesses are hiring, so they'll be watching out for interest rate rises. The worry is that the policy could be counter-productive. In theory, if there is an interest rate rise, businesses could be less likely to go out and spend and hire people."

"This is the mess central bankers have got themselves into. There are better economic indicators."

David Kern, chief economist at the British Chambers of Commerce, agreed with Jarman's concern.

"Once you accept that some point interest rates will have to be edged up and any time you do that will cause a problem, the challenge becomes the way to raise interest rates at the least damaging time and so if when unemployment approaches 7% it is still the case that the economy is still very fragile then the [Bank of England Monetary Policy] committee can actually make it clear and adjust their guidance," he told the Huffington Post UK.

"Every businessperson would agree that interest rates have to be put up."

In order to see the headline unemployment figure fall from its current level of 7.8% to 7.0%, 750,000 jobs would need to be created. The Bank sees UK unemployment staying above 7% at least until the third quarter of 2016.

Other experts have warned that the employment figure does not reflect the whole state of the UK employment market. TUC senior economist Duncan Weldon told the Huffington Post UK that "it's not ideal, it doesn't take account for underemployment nor job-quality."

Weldon questioned why the Bank of England set an unemployment target of 7% as the key factor governing interest rates rather than 6.5%, as set by the US Federal Reserve. "Maybe some of Carney's more hawkish colleagues have had an influence, but it's an easier number to achieve," he said.

The Bank Of England predicted that unemployment would be unlikely to fall to 7% until 2016 and insisted the bank "stands ready" to pursue more money printing if unemployment remains stubbornly above that.

Jarman said Carney's forward guidance policy served as a "political" gesture that Chancellor George Osborne would welcome in the run-up to the 2015 general election.

"What are the government trying to achieve here? They’re starting to inflate the housing market again without really seeing any substance in wage inflation, if anything we’re going to get squeezed more.

"They want to make everyone feel like the economy is holding up with record low interest rates. That's all this is, they'll readjust it once the election is held."

Despite the criticism, others have welcomed Carney's forward guidance more positively.

Matthew Whittaker, senior economist at the Resolution Foundation, said: “The intention to keep interest rates low offers help to the substantial number of households with high levels of debt. There are currently about 600,000 families spending more than half their net income on debt repayments and this number is highly sensitive to future borrowing costs. Sharper than expected rises in inflation would have serious consequences for highly-indebted families and the economy more widely.

“Alongside the continued uncertainty around jobs, wages and prices the debt overhang therefore represents a significant constraint on the Bank of England.

“Forward guidance shows the Bank’s commitment to maintaining a loose monetary stance but it is vital that banks, consumers and policy makers take advantage of this window of opportunity to reduce problem debt.”