It very much sounds like we are about to have the making of the UK economy’s first squeal directed by nobody else than Threadneedle Street, Forward Guidance Part 2.
Goodbye to Forward Guidance Part 1 and welcome to Part 2! I bet the suspense is killing you.
With the introduction of forward guidance only six months ago, has it really worked as well as we might think? I am of the opinion, not really, unemployment has fallen which they have used as an indicator to determine movement in interest rates. This was particularly blind sighted, it has given too much pressure on one particular indicator with a caveat on controllable inflation, and there are many more factors in a developed economy they need to be considered.
Due to the rapid fall in unemployment, it has amplified the pressure on the MPC to hike rates. Traders have been pricing this in, with GBP crosses being very bid, however with the dovish comments from the BoE recently, there has been a significant lack in confidence and they have fallen back significantly.
Comments such as they have been too “unnecessarily focusing on one indicator” and that they “there are a board range of things we could do” and “no immediate need to increase interest rate”. The wording alone does not inspire confidence and shows that they know there is a lot water to flow under the bridge just yet. They have put to much pressure on the system by not have a more diversified outlook or structured plan and are now back pedalling.
There is huge pressure that the UK economy does not stagnate and patients is required to ensure the economy is growing at a steady and stable pace before pumping on the breaks. Good crosschecks need to be implemented to ensure that all parts of the economy are benefiting from the recovery before acting with haste.
It is often forgotten, that it harder to inspire confidence and growth in an economy if there isn’t any at all, momentum is a huge part of it and control is key. The phase learning to run before you can walk comes to mind.
There are many other methods of control that could be looked at; there could be a reduction in asset purchasing. It has been discussed by David Miles that the “unwinding of such asset purchases is likely to occur when financial markets are operating more normally”. Could this be a good time to try to reduce stimulus, slowly initially as a test, not as rapid as the tapering process in the States but more experimental initially.
In the short term the MPC will be looking at a range of options to modernise the current programme, most likely looking at the behaviour of aggregate supply in the economy, inflationary pressures as well as other indicators to give a more detailed overview of the strength of the economy.
To conclude, there is one thing that is clear, they are not going to change interest rate this month so don’t hold your breath on that, however going forward, wording and phasing will be key to give us a slight indication of what is to come.