With the UK unemployment rate falling faster than expected towards his 7.0 per cent threshold as the economic recovery picks up steam, Bank of England Governor Mark Carney is under pressure from the markets to update his forward guidance on interest rates when he presents his quarterly inflation review.
The Monetary Policy Committee will also reveal its quarterly forecasts for growth and inflation
By Sarah O’Connor and John Aglionby
Here’s a quick round up of what economists are saying this morning ahead of the Inflation report. From Barclays:
We think the MPC is gradually moving towards a more qualitative type of guidance and that it will emphasise that it looks at a range of indicators when making its policy decision. At the same time we believe the committee will continue to move away from putting too much emphasis on a single indicator; as a result, lowering the unemployment rate (UR) threshold to below 7.0% seems unlikely
This is the chart that is causing Mark Carney sleepless nights. Or, at the very least, upset his forward guidance policy that was announced in August. At the time, Carney thought the unemployment rate would fall to 7.0 per cent in mid-2016. It now looks likely to get there in a month or two, if the current economic conditions continue.
From Michael Hunter on the markets desk:
Before the publication of the report, the pound was flat against the dollar at $1.6454. The FTSE 250, the equities index more rooted in the UK economy, was also flat at 16,084.32, with the FTSE 100 up 0.5 per cent at 6,704.39.
Here is Peter Dixon from Commerzbank, who is quite critical of the MPC:
The debate about how long rates should remain at 0.5% is increasingly becoming divorced from economic fundamentals. Interest rates are at the same levels as in March 2009 when the economy threatened to go into meltdown. The overall monetary policy stance is even more lax once we account for the huge amount of QE undertaken since then. In the last twelve months alone, there has been a significant improvement in economic conditions. Raising rates by anything up to 150 bps from current levels will only take them from the lowest level in the BoE’s 320 year history to their second lowest level. The longer the BoE continues to kick the debate on rate hikes into the long grass, the more open it will be to criticism that factors other than economics are at play.
Economics editor Chris Giles, who has read the inflation report, says the Bank of England said y that interest rates “may need to remain at low levels for some time to come”, suggesting that financial markets are right not to expect interest rates before the election next year.
The pound moved higher as the report was published. Having been flat against the dollar beforehand, it’s now up 0.5 per cent $1.6519
Mark Carney, in his opening remarks, makes a defence of guidance, which has come in for much criticism. He says “virtually all businesses understand guidance” and three quarters say it has helped them to feel more confident.
More from Economics editor Chris Giles:
Ditching the previous guidance linking interest rates to unemployment, the bank’s Monetary Policy Committee’s new idea is to give much more information about its thinking on interest rates without giving a precise forecast.
In a dovish assessment, the MPC said that there was no need for any imminent rate rise; when rates do rise they will go up on a “gradual path” and the medium term level of rates will be “materially below the 5 per cent level set on average by the committee prior to the financial crisis”.
The MPC indicated that it thought the financial markets expectations of interest rates were reasonable by providing forecasts for inflation showing price increases close to the 2 per cent target over the next three years.
The implication is that interest rates will rise around 1.5 percentage points between spring 2015 and 2017.
The MPC based the forecasts on market interest rates that remain constant until the second quarter of 2015 and rising only to 2 per cent in three years time with a medium term level of rates not exceeding 3 per cent.
The MPC added that it would keep the stock of assets purchased under quantitative easing at £375bn at least until it first increased interest rates.
Carney says the unemployment rate is likely to reach the 7 per cent threshold by the spring. So now is the time to take a closer look at how much slack remains in the economy.
More instant market reaction:
The FTSE 250 remains flat – at 16,081.29, while the FTSE 100 is marginally off session higs which took it 0.5 per cent higher. London’s main equities index is now 0.4 per cent higher on the day at 6,696.99.
Here’s a link to the quarterly inflation report:
The inflation environment is “more benign” than the MPC had anticipated, Carney says. And there’s likely to be less upward pressure from administered prices in the next few years.
“The question is, what’s next?” says Carney. His new guidance has five elements.
Economics editor Chris Giles says Mark Carney is putting a brave face on his forward guidance U-turn. He says it has worked well and businesses understand it. What “it” is is less clear…
Here is the Bank’s latest estimate on GDP growth:
Carney: The MPC will not take risks with this recovery”
And here’s the Bank’s latest forecast for unemployment:
And here’s the Bank’s forecast for CPI inflation:
We’re onto the Q&A. First question, from the BBC: “What are borrowers to make of all this”? Carney insists the first phase of forward guidance worked – it reassured people that the Bank of England wouldn’t pull the rug out from under the economy. “Now we’re in a different place – the economy’s been growing strongly…and we’ve taken stock.” We are still looking to maintain the momentum in the recovery but we have to make more nuanced judgements. Our new framework is clear about how much spare capacity is in the labour market – 1 to 1.5% of GDP. “This won’t be the last discussion about these issues – we’ve laid out more information than we ever had…We are giving 20 interviews and 8 speeches between now and the next inflation report in 3 months.”
Carney: What did we get wrong six months ago? In terms of the forecast for unemployment – the economy has been stronger than we thought. But the big thing that hasn’t transpired that we thought is over productivity. It hasn’t picked up as we thought. Productivity is notoriously difficult to measure and forecast.
He adds that productivity is not expected to return to its pre-crisis level for another three years.
Carney: We’ve got one of the strongest economies int he developed world. If you look against outcomes against which we should be measured, this is a good place to be.
Page 8 of the Inflation Report lays out this “next phase” of guidance. It’s a long list.
Carney: Part of the point of guidance was to learn as we went along the way. We’ve learnt. We didn’t expect to be here at this point in time. But we’ve learnt things. So we can adapt our broader guidance, as we’ve done today.
Next question from the Guardian: If I’m a member of the public and I tell you – the BoE failed to spot the bubble, the bust, the rise in inflation…why should I believe you about the future path of interest rates?
From FT economics reporter Emily Cadman:
Carney – on the big calls we were right, on when the economy was turning, when to “look through” price shocks, how quickly to cut rates in the crash, and then to provide guidance
A question about exports and rebalancing the economy: Carney says, in terms of the challenges to this recovery, the export performance is the most difficult. That is a product of the weakness of our main trading partner. There is [also] the persistent strength of sterling. But there’s the underlying question of whether productivity will pick up and whether business investment will rrespond.
Next question, on whether market’s expectations on rate rises are warranted. (Last year the BoE warned the market’s expectations were out of line). Carney doesn’t want to be drawn on that this time. “We’re specifically not giving time-contingent guidance.”
Question from Chris Giles on how long this phase of guidance is expected to last. Carney waffles a bit but says: We’re in a situation where there’s notable spare capacity in the economy – esp in the labour market where it mostly lies. We think we can draw down that spare capacity further before needing to adjust the bank rate.”
In short, he doesn’t answer
Here’s a quick reaction from Richard Barwell, economist at RBS (and formerly of the Bank of England). He thinks the new guidance is a “mixed bag”:
The discussion of scenarios and the publication of more information is genuine progress. The failure to communicate a clear message on the optimal path for Bank Rate and the continuing ambiguity over the prospects of gilt sales is a disappointment.
A question about how close to full capacity the economy needs to be before rates start to rise. (A reminder: the BoE thinks there is 1 to 1.5% of GDP worth of slack right now) Charlie Bean answers this one: there will be lags between monetary policy and its impact on activity. Risks of starting too early – or leaving it too late.
From the FT’s Martin Sandbu:
Carney asked (again) to sum up what all this actually means. He replies: the message to business is that we’re going to set an appropriate path for monetary policy so that the economy continues to grow. When the point comes (for rates to start rising) the adjustments will be gradual and limited.
He insists, again, that unemployment “was the right metric to use”.
Sterling has appreciated about 10 per cent since the March trough, Carney says. He said the MPC doesn’t pass through small movements in the currency. But he admits the movement is having an impact on net exports. He says inflation is expected to be close to target but slightly below.
FT economics editor Chris Giles is not entirely happy with Carney’s answers:
Carney: What we’re not doing is publishing a path of expected interest rates. We talked about that in the summer when we thought about guidance, but it’s not our preferred strategy.
This from John Philpott, a labour market expert, who runs his own consultancy.
A question on Scotland: How would Carney feel about Scotland using the pound if there is no currency union. “What we will do in any circumstance is to discharge the remit given by the relevant democratic authorities.” He declines to discuss hypotheticals.
I wouldn’t be a pessimist about the ability to return to normal rates reflecting a normal economy, says Carney. But that’s quite a way off (beyond the MPC’s forecast horizon).
Question on the cost of living squeeze and wages – when will wages exceed inflation.
Carney says disposable income per head has grown very softly in the last fivbve eyars but expects this to turn this year.
He turns to Spencer Dale, who says the MPC expects wages to be growing more quickly than inflation “at some point in the second half of this year” but adds this is dependent on a pick-up in productivity.
Can you rule out a rate hike this year? “That would be giving time-contingent guidance” quips Carney.
Michael Hunter from the FT’s markets desk says sterling’s rise has continued as the Q&A has progressed.
The pound is currently up 0.6 per cent at $1.6547.
On the Bank of England’s communications strategy, Carney says what he has tried to do is “consistently increase the amount of information and provide the context”. The bank is offering scenario analysis, key judgements, assessments of where forecasts went wrong, for example. He is also doing press conferences after all his speeches. Spencer Dale, chief economist, also did a surprisingly good Q&A on Twitter.
Media professor Charlie Beckett comments:
Commentator David Buik rides to Carney’s rescue:
Why didn’t Carney and the MPC copy the Fed’s “dot charts” or give a forecast for the path of rates, asks the Telegraph? (Some economists had thought they might go down this route). Carney replies this mixes up forecasts and the MPC’s reaction function. He adds: “Ultimately the objective is to get back to some form of equilibrium. It is not clear that there’s any reason why the longer term natural rate of unemployment has moved from the pre-crisis level of about 5 per cent.”
Question on GDP bullishness and the lack of a “sustained and balanced recovery”
Carney: We’re serene but not complacent” about this recovery. “It’s very important that there’s the hand-off to business investment this year.”
“We should stop and talk about the 3.4 per cent [forecast for GDP].”
Spencer Dale: 3.4 per cent is the annual average growth rate, rather than the actual growth rate. He says some of it reflects that the economy grew strongly at the end of last year.
Some reaction from James Knightley, an economist at ING:
The BoE are moving away from simply looking at the unemployment rate and broadening it out to include other variables. These include the labour force participation rate, hours worked, productivity and wages. This is all rather vague with no specific numerical targets so effectively the message remains that the Bank of England is going to try and delay interest rate rises as long as possible. Carney also added that “persistent headwinds mean that even in the medium term the level of interest rates necessary to sustain low unemployment and price stability will be materially lower than before the crisis.” This is something we have long believed, particularly with high levels of debt being increasingly concentrated in certain demographics, making these groups much more vulnerable to higher interest rates. That said, the strength of the growth story coupled with the robustness of the labour market means that the BoE are likely fighting a losing battle in convincing markets that rate hikes are a distant prospect.
Another question on the lack of balance in the economy:
Carney says the current account deficit is “notable”. “There’s an element on the trade side and weakness in Europe, but also in the net investment income position. It’s hard to be precise about why but part of this is being driven by weakness in Europe. So there should be some recovery of that as Europe has stabilised.”
“People are producing output, they’re not becoming radically more prodeuctive. Labour is being priced into the job market. A lot of those who are working are involuntary part time. I would work backwards from productivity and consumption growth is likely to be soft”.
A little summary on statistics:
The BoE has said it expects inflation to be 1.9 per cent until early 2017 and growth to be 3.4 per cent this year, up form 2.8 per cent.
Mark Carney declined to discuss when rates might rise but said it was unlikely to be before the middle of next year. The reasons for this were the continued slack in the labour market and the low productivity that continues to dog the UK economy.
A question on the eurozone. Carney says there has been progress on rebalancing in Europe and “some” progress on financial repair. Paul Fisher, head of markets at the BoE, points out that speads on the debt of peripheral eurozone countries are tightening. “At the moment there is market confidence in the future of the euro. Leaders remain committed to the European project, but it’s a long road.” He dodges a specific question about Germany’s referral of OMT to the ECJ.
Carney: The objective is not to have forward guidance for ever. No one is enjoying this period. It was first about securing a nascent recovery and then about proceeding with the recovery. Bank rates are going to be calibrated carefully. Ultimately, if the recovery proceeds rate rises will be gradual, limited and appropriate”.
And with that the press conference ends
A quick summary:
The Bank of England has dropped its first version of “forward guidance”, which linked monetary policy to the unemployment rate. This was flagged by Carney in a Newsnight interview in Davos, so comes as no surprise.
The MPC has replaced that guidance with something broader but much more complicated. It has said that the MPC will seek to use policy to absorb the economy’s spare capacity; that there is scope to use up more spare capacity before raising rates; that when rates do rise, they will only rise gradually; that any rises in rates will be limited; and that the stock of asset purchases through QE will remain untouched until rates rise.
The overall tone of all this is dovish: there is no need to increase interest rates yet and even when they do go up it will only happen gradually.
And as for the markets, they haven’t really moved from where they were during the press conference – sterling up about 0.6 per cent, equities also stronger, the FTSE 100 is about 0.4 per cent up on the day.
From (relative) simplicity to complexity: the first version of forward guidance was fairly straightforward. Here is the BoE’s summary of the re-vamped version:
We’re going to end our live coverage now. Thanks for following and your comments.