Market view: Forward guidance is ‘careful balancing act’

Policymaker Martin Weale voted against new Bank of England governor Mark Carney’s policy to link interest rates with employment, minutes of the latest Monetary Policy Committee meeting, published today (14 August) revealed.

The minutes of the 31 July - 1 August meeting revealed that although he supported guidance in general, Mr Weale thought that the inflation “knockout” should apply over a shorter time period than the 18 to 24 months agreed.

Ruth Lea, economic adviser to the Arbuthnot Banking Group, told FTAdviser that Mr Weale was “right” to look for a tighter inflation knockout target.

Article continues after advert

She said: “I say rightly because the knockout of 2.5 per cent over the next 18 to 24 months seems unduly tolerant and gives the impression that the Bank is going soft (softer) on inflation. But the minutes clearly endorsed the forward statement as announced by Governor Carney.”

Katie Evans, economist at the Centre for Economics and Business Research, said the bank has safeguarded its credibility by admitting that interest rates will rise regardless of unemployment levels if inflation is expected to be above 2.5 per cent 18 months to two years ahead, or if inflation expectations rise or loose monetary policy is judged to pose a threat to stability.

However, the “knockout clauses” have been met with skepticism from some, with forward interest rates implying that the base rate will rise in the summer of 2015, not early 2016 as the MPC has indicated, according to Ms Evans.

Gilt yields rose to two year highs last night (13 August) ahead of this morning’s UK jobs data, which has taken on a new significance now that interest rates - and to an extent asset purchases - have been linked with the unemployment rate.

Ms Evans said: “The difficulties of convincing markets that rates will remain low have become obvious as the yield on UK gilts rose to its highest level since October 2011 on Tuesday.

“Amid a stream of positive economic data, other factors are clearly expecting the economy to recover more quickly than the bank. And as the rates households and businesses face reflect markets rather than the base rate, forward guidance may fail to stimulate economic growth as anticipated.”

Ms Lea said: “The markets clearly took the view last week that interest rates would rise before Carney’s ‘three-year time horizon’ (based on his unemployment forecast) - and gilt yields actually rose. If the unemployment rate remains stable then gilt yields could well fall back - the markets would be postponing their expectation of higher rates.”

Unemployment figures are now more significant than ever, following the Bank of England’s announcement that it will not raise interest rates or reduce the stock of assets purchased under its quantitative easing scheme until the rate falls to 7 per cent.

Data released by the Office for National Statistics showed that the UK unemployment rate was unchanged in the three months to June at 7.8 per cent, the same as in the previous quarter.