The Bank of England’s next quarterly inflation report (Wednesday) will determine whether forward guidance gets a slight make-over. Unemployment at 7.1% is hovering just above the 7.0% threshold that the Bank set in forward guidance for considering a rate rise.
In August, when that policy was outlined, unemployment stood at 7.8 per cent. The Bank’s forward guidance target of unemployment falling to 7.0%, before it would consider a rate rise, looks like being achieved much sooner than it expected and it is now up to the Bank to provide firm guidance. There are three possibilities:
1. The Bank will lower its unemployment target to around 6.5% keeping all other rhetoric as is. This opinion may stem from Mr. Carneys speech, in December, to a House of Lords committee when he said: ‘It is welcome that the economy is growing again, but a return to growth is not yet a return to normality.’ Mr Carney added: ‘The recovery has some way to run before it would be appropriate to consider adjusting the exceptional level of monetary stimulus that we continue to provide to the economy.’
2. Taking the ‘American approach’ and simply stating that rates can and will remain on hold well past the previous 7.0% unemployment target.
3. Raising rates, with an eye to possible deflation and the reasoning that target has been met, albeit sooner than expected.
There exists almost universal agreement that a rate rise will not occur until later this year at the very earliest. The money markets seem to agree, with the interest rate curve forecasting a first base rate rise to 0.75 per cent in early 2015.
It is not Mr. Carneys style to issue ‘steam-roller speeches’ a la Fed. This option is made even more unlikely since Mr. Carney has previously stated that 7.0% would not be considered a trigger but a target. It is far more likely that up-coming pronouncements with respect to a rate rise will be linked either to a renewed unemployment target, or a new indicator; thus creating a shift of focus. The new focus may be on wage growth or nominal G.D.P.
Inflation is expected to remain at 2.0% and the M.P.C. voted, on the 6th, to keep the rate at 0.5% whilst maintaining Q.E. levels.
With respect to the interest rate and markets, no-one is expecting a rate hike and the market status quo should remain until further data is released.