4 Min Read
* BoE challenged on new view of jobs impact on inflation
* Carney says questions raised over years about link
* Lawmakers press BoE on forecasting record
* Carney says pickup in wages would test BoE on rates (Add details, background)
By David Milliken and William Schomberg
LONDON, Feb 21 (Reuters) - Bank of England Governor Mark Carney faced a challenge from lawmakers on Tuesday over the way the BoE changed one of its fundamental assumptions about Britain's economy, which helps it justify keeping interest rates at a record low.
The central bank surprised investors when it said earlier this month that it believed the unemployment rate could fall to 4.5 percent - down from a previous estimate of 5 percent - before it starts to push up inflation.
That could help the BoE to keep rates low for longer, despite the unexpected strength of Britain's economy after voters decided last year to leave the European Union.
Britain's jobless rate stands at an 11-year low of 4.8 percent. But wage growth has remained weaker than before the 2007-09 financial crisis, prompting the BoE to rethink the links between jobs growth, pay and inflation.
In a meeting with lawmakers who focused on the central bank's patchy forecasting record, Carney was pressed to explain why the BoE had changed its estimate of the so-called "equilibrium unemployment rate" for the first time in years.
"This matters a lot because the Bank of England can allow forecast growth to rise without inflationary consequences once you've lowered this number," Andrew Tyrie, the head of a panel of members of parliament that monitors the BoE, told Carney.
"And indeed that seems to be a crucial ingredient for your making of assumptions on whether to raise interest rates."
In a sometimes testy exchange, Carney said some members of the Bank's Monetary Policy Committee had felt for years that the equilibrium unemployment rate estimate was too high, and the decision to lower it was the result of an annual review.
BoE Chief Economist Andy Haldane backed up Carney: "It's been there in the ether for quite a number of years. This is not a snap judgment we have suddenly made."
However, one MPC member, Ian McCafferty, told the lawmakers that he believed the rate stood at 4.75 percent, slightly higher than the consensus view of the nine-member committee.
Earlier this month, fellow rate setter Kristin Forbes also said she believed the rate was not as low at 4.5 percent, and that there could soon be a case to raise interest rates.
In his comments on Tuesday, Carney said the BoE remained convinced that a forecast overshoot in inflation in Britain was entirely due to the fall in the value of the pound since the Brexit vote.
But if the pick-up in inflation started to fuel higher pay settlements, it would push the BoE closer to its limit for tolerating inflation overshooting its 2 percent target, he said.
"If (inflation) starts to influence wage behaviour and other price behaviour, and we start to see domestically generated consequences of that, that moves us closer to the limit," Carney said.
Gertjan Vlieghe, an external member of the MPC, also warned the politicians against expecting too much from economic forecasts at the BoE or elsewhere.
"We are probably not going to forecast the next financial crisis, nor are we going to forecast the next recession. Models are just not that good," he said.
Most economists polled by Reuters this month predicted the first BoE rate change in 2019 at the earliest.
Sterling weakened against the U.S. dollar and the euro as Carney and his fellow BoE officials spoke on Tuesday.
Market interest rates rose earlier this year as investors speculated that Britain's strong economic growth in 2016, despite the Brexit vote, would push the BoE to raise borrowing costs.
The BoE dampened that speculation this month when it signalled it was in no hurry to raise rates, in part due to its view on the lower equilibrium interest rate. (Additional reporting by Kate Holton, William James and James Davey; writing by William Schomberg; editing by Larry King)