LONDON, Feb. 12 (Xinhua) -- Economists said the robust recovery in the British economy has prompted the Bank of England (BOE) to revise its key Forward Guidance policy on Wednesday.
In its quarterly Inflation Report, the BOE raised its forecast for gross domestic product (GDP) growth this year from 2.8 percent to 3.4 percent and for 2015 to 2.7 percent from 2.3 percent.
This reflects the surprising growth in the economy in 2013 of 1.9 percent, with the final two quarters recording 0.8 and 0.7 percent quarter-on-quarter growth respectively, which was unexpected at the beginning of 2013 by most commentators.
The BOE also forecast inflation at 1.9 percent in three years' time (currently at 2.1 percent, close to the 2 percent target) and it also forecast consumer price index undershooting the 2 percent target at the two-year horizon (1.7 percent against the previous 1.9 forecast).
James Knightley, chief Britain economist with ING Bank, said BOE acknowledged that the economy has grown robustly with employment gains which it described as "exceptionally strong."
Knightley said the BOE believes that there is "wasteful" spare capacity still in the economy, to the tune of 1-1.5 percent of GDP, concentrated in the labor market.
"As such, it has changed its Forward Guidance (FG) to effectively be one that targets a closure of this output gap before interest rates start to rise," Knightley said.
The first evolution of FG policy, as outlined in the BOE's August Inflation Report, targeted 7 percent unemployment as the threshold for Bank Rate review.
This target has been approached much faster than anticipated and BOE believed it would be spring 2016 before it was reached, with the jobless rate at 7.1 percent.
Knightley said the BOE is "moving away from simply looking at the unemployment rate and broadening it out to include other variables."
These include labor force participation rate, hours worked, productivity and wages.
Knightley forecast the first rate rise for February next year, warning that "if we are correct on the employment/wage dynamic we see the threat of an earlier move."
Knightley said, "We see upside risk in the medium term for inflation given the likelihood that wages should start to respond to the shrinking pool of available labor."
He said that the Bank Rate was likely to settle in the 3.5-4 percent range.
The initial move to higher yields suggests markets interpret the BOE's shift to a more complex composite measure of spare capacity as "a less convincing commitment not to hike rates than the previous framework," said Sam Hill, senior Britain economist with RBC Capital Markets.
Hill said the BOE had set out four key judgments underpinned by 18 variables so that risks around those judgments, and hence the implications for policy, can be assessed.
Under this new FG framework, how the Bank Rate is affected is dependent on the rate at which spare capacity in the economy is used up, said Hill.
There are uncertainties around this policy, said Hill, "Potential supply growth is dependent both on productivity and population growth."
Hill said he expected rates to be at 0.5 percent until November 2015.