Mark Carney axes employment link in forward guidance overhaul
Bank of England governor Mark Carney has changed how the Bank will use forward guidance to target spare capacity in the economy, just six months after first introducing the policy into the UK.
Speaking today, Carney declared forward guidance to have worked so far but reassured that interest rates would remain low “for some time to come”, despite unemployment recently falling close to its 7 per cent threshold limit.
The overhaul of forward guidance sees the direct link with employment dropped so the Bank can focus on a much wider range of indicators.
Presenting today’s Inflation Report the governor outlined “the next phase” of forward guidance, saying the Bank aims to see all spare capacity in the UK economy absorbed before it will lift the base rate and reduce quantitative easing.
“The MPC is for the first time today providing guidance that it is seeking to absorb all the spare capacity in the economy over the next two to three years,” Carney said. “That recognises that spare capacity is both wasteful and increases the risk that inflation will undershoot the target in the medium term.
”For a sustained and balanced recovery, the degree of stimulus will need to remain exceptional for some time.”
As part of this, the Monetary Policy Committee will now examine a range of indicators to guide the time of policy decisions, rather than watching the headline unemployment rate. This will see the Bank publish forecasts of 18 more economic indicators for the first time.
As well as unemployment, the MPC will monitor factors such as participation in the labour market, average hours worked and the extent of involuntary part-time working, surveys of spare capacity in companies, labour productivity and wages.
Carney also said the base rate will only rise gradually “if and when the time comes that the economy can sustain higher interest rates”. These limited increases are to protect against the “many” headwinds that threaten to hold back the economy.
In addition, the governor said the Bank will maintain its current QE programme until the first rise in the base rate.
Carney concluded: “The bank rate may need to stay at low levels for some time to come. The first phase of guidance gave businesses confidence that bank rate would not be raised at least until jobs, incomes and spending were growing at sustainable rates.
“As guidance evolves, that remains the case: the MPC will not take risks with the recovery.”
In August, the governor said the Bank would not consider lifting interest rates until the UK’s unemployment rate fell to 7 per cent, as long as inflation did not get out of hand and no threats to financial stability emerged.
At the time, the unemployment rate stood at 7.8 per cent and the Bank expected median unemployment to be 7.3 per cent over the next three years. However, it has since fallen to just 7.1 per cent.
During the recent World Economic Forum meeting in Davos, Carney said he would consider a wide range of options for updating forward guidance policy in light of the unemployment rate being close to the threshold limit sooner than expected.
Old Mutual Strategic Bond fund manager Stewart Cowley says: “Setting strict economic targets for interest policy is like playing soccer with a rugby ball – it’s too imprecise and no matter your intentions it will bounce off course. Unemployment numbers don’t take into account the breadth of human experience and is too coarse a measure to be useful for policy setting.
“In that case it isn’t surprising that the BOE abandons strict numerical targeting. What a capitalist economy like we have in the UK needs is a new and vigorous credit cycle built on a stable banking system and a working population that has the confidence and self-assurance to borrow.”