New Bank of England governor Mark Carney gave households and businesses a boost as he said interest rates will remain at their record low until unemployment falls below 7%.
Unveiling a new strategy of forward guidance, the Bank said rates will remain at 0.5% until at least the end of 2016 unless inflation rises sharply.
Mr Carney said “a renewed recovery is now under way” as the Bank predicted 0.6% growth in the third quarter and said inflation is unlikely to rise above 3% this year – lower than previous fears of a peak of around 3.5%.
The Bank also pledged not to scale back its ï¿½375bn economy-boosting programme of quantitative easing (QE) while unemployment remains above 7%.
Mr Carney said unemployment falling to 7% would mean more than 750,000 UK jobs are created, which, combined with rising wages, would represent “real improvements in the lives of people across the nation”.
He said the Bank looked at a range of measures in deciding to link rates guidance to unemployment.
He added unemployment was chosen as “people running businesses and individuals across the country understand the conditions under which the Monetary Policy Committee (MPC) would begin to consider the withdrawal of stimulus”.
Unemployment is running at 7.8% and the Bank predicted it will remain above 7% until at least the third quarter of 2016.
This signals that rates will therefore remain at historic lows for at least another three years.
Mr Carney said: “Unemployment is still high. There are one million more people unemployed today than before this financial crisis and many who have jobs would like to work more than they currently can.”
The Bank warned that it will break the link with unemployment if it fears inflation will be 2.5% or higher in the next 18 months to two years or if there are worries about it climbing sharply in the medium term.
Chancellor George Osborne welcomed the introduction of forward guidance by the Bank.
In a letter to Mr Carney, Mr Osborne said: “Given the exceptional economic challenges continuing to face the UK economy, I agree with you that forward guidance can play a useful role in enhancing the effectiveness of monetary policy and thereby supporting the recovery.”
But, despite mounting signs that Britain’s recovery is picking up pace, Mr Carney dampened hopes the UK has returned to an economic boom, saying: “We are not at escape velocity right now.”
Vicky Redwood, chief UK economist at consultancy Capital Economics, said the Bank's guidance was a “clear steer that interest rates will stay on hold until the end of 2016 or even 2017”.
“Although financial markets already expected rates to stay low for a long time, this probably exceeds their expectations,” she added.
The Bank’s move sees it follow in the footsteps of the US Federal Reserve, which turned to forward guidance late last year.
There are one million more people unemployed today than before this financial crisis