By David Milliken
NOTTINGHAM, England (Reuters) - The Bank of England may provide more stimulus for Britain's economy if financial markets get ahead of themselves and threaten to choke off its recovery, its governor said on Wednesday.
In his first policy speech since taking over the bank, Mark Carney also announced a relaxation of rules for banks which could boost lending and help Britain's "solid but not stellar" emergence from its deep recession.
Financial markets have challenged the BoE's new plan to keep interest rates on hold for possibly three more years and Carney said the bank could provide more stimulus if premature rate hike expectations added to risks facing the recovery.
"The upward move in market expectations of where Bank Rate will head in future could, at the margin, feed into the effective financial conditions facing the real economy," Carney said, adding policymakers would watch those conditions closely.
"If they tighten, and the recovery seems to be falling short of the strong growth we need, we will consider carefully whether, and how best, to stimulate the recovery further."
Sterling initially weakened but recovered its losses against the dollar and expectations that the BoE might have to raise interest rates in 2015, a year earlier than its plan implies, were little changed. British government bond prices fell, pushing up yields further, as investors worried that the new bank rules could lead to sales of gilts.
Carney sought to underscore his message that the BoE's new forward guidance plan - something he deployed while running the Bank of Canada and helped land him the job in London - was not reliant on how financial markets responded.
"Hanging this on markets is to miss the point," he told reporters after making his speech to business representatives in the city of Nottingham, far from London's financial hub.
"What my colleagues and what I am hearing across the country is that there is appreciation for that greater degree of certainty that is being provided by the bank," he said.
The BoE's interest rates, not market rates, were most important to most households and businesses, Carney said.
Philip Rush, an economist with Nomura, said the comments on more stimulus did not appear to signal any imminent new move.
"Easing is not ruled out if higher rates start to impair recovery but that point does not seem upon us," Rush said. "While higher rates reflect stronger growth, easing would constitute a negative confidence shock - i.e. the opposite of what the BoE is trying to achieve."
The Bank of England spent 375 billion pounds ($580 billion) on government bonds between 2009 and last year to try to prop up Britain's economy after the financial crisis.
Carney said the option of further stimulus was part of the forward guidance plan announced by the BoE this month. That plan mentioned the possibility of further asset purchases. Carney declined to go into detail on stimulus options on Wednesday.
Most of the bank's nine top policymakers are opposed to a revival of the bond-buying program although it was supported by Carney's predecessor Mervyn King.
And if it did want to do more to help growth, the bank would need to show it can keep its foot on the stimulus pedal without pushing up already above-target inflation.
That challenge was made greater after one of the BoE's policymakers voted against the forward guidance earlier this month, voicing concerns about inflation.
Carney dedicated much of his speech to explaining why the central bank believed unemployment would fall only slowly, pointing to expected further job losses for public workers and large numbers of part-time workers who want to work full-time.
Markets appear to expect unemployment to fall to 7 percent by mid 2015 but Carney said the bank saw only a one in three chance of this happening.
He said the BoE remained committed to fighting inflation but it was right for it to allow it to come back down to its 2 percent target only slowly, given the weak state of the economy and temporary factors pushing up price growth.
Carney announced a widening of a planned relaxation of rules on banks and building societies, on condition they meet new requirements on capital buffers.
Under the change, eight major lenders in Britain would be allowed to reduce their required liquid asset holdings - cash and safe but low-yielding investments - by 90 billion pounds if they meet the minimum 7 percent capital requirement, freeing up more money for lending and in turn spurring growth.
That kind of increase in the potential supply of credit had the potential to provide "a significant jolt" towards getting lending back to normal although it remained to be seen if companies were confident enough to borrow more, said Simon Hayes, an economist with Barclays.
In a nod to concerns about the property market heating up again, Carney said the BoE was "acutely aware" of the risk of unsustainable credit and house price growth but said gauges of the housing market and household borrowing costs were not at historically high levels. ($1 = 0.6435 British pounds)
(Additional reporting by London markets and economics teams; Writing by William Schomberg; Editing by Jeremy Gaunt and Toby Chopra)