Carney goes sideways on forward guidance

The Bank of England has ditched the link between unemployment and interest rate rises and hiked up its growth forecast.

by Rachel Savage
Last Updated: 18 Feb 2014

Bank of England governor Mark Carney has dropped the link between the unemployment rate and putting up interest rates, after introducing it in his flagship forward guidance policy just last August (there’s nothing like 13 years at Goldman Sachs to teach you how to adapt to the unexpected).

Carney had said the Bank would consider raising interest rates from the record low of 0.5% when unemployment fell to 7%, but was caught short when it fell to 7.1% in the three months to November. Instead, the Bank will look at a range of economic indicators, including unwanted part-time work, productivity, wages and spare capacity in the economy, which means more work for economists explaining that all to the rest of us.

The Bank governor said that interest rates ‘may need to remain at low levels for some time to come’, and indicated they probably won’t be raised until the second half of 2015, after the general election. The central bank will keep on buying assets under its quantitative easing policy until at least the first rate rise.

We shouldn’t expect rates to return to the 5% level they were at before the financial crisis any time soon either – the Bank said in its Inflation Report 2-3% would be the ‘new normal’. Hard luck savers.

Carney claimed that forward guidance had ‘worked’ after the Bank ‘saw that the recovery was going to gain momentum’ and ‘took steps to reinforce that’. In a strangely poetic turn of phase, the Bank described itself as ‘serene but not complacent’.

The Bank whacked up its GDP forecast to 3.4% for this year from its previous estimate of 2.8%, way above the 2.4% the Office for National Statistics expects. That is based on the assumption that the ONS will revise up 2013’s fourth quarter growth from 0.7% to 0.9%.

The Inflation Report also estimated the output gap (between current activity and the economy running at full steam) is 1.5%, and warned the ‘spare capacity’ was upping the risk that inflation would undershoot the Bank’s 2% target.

Investment is expected to boom by 11.5% this year, compared to a 3.3% fall in 2013. The CBI said yesterday that it thinks investment will grow 6.6% this year. However, the Bank said a lack of exports would drag down the economy in the next couple of years.

Carney’s forward guidance certainly hasn’t trampled on growth, but whether the governor can keep up his credibility after losing the 7% threshold remains to be seen.

Tags:
Economy

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