Today has seen what has become the set piece event of UK monetary policy which is the release of the quarterly Inflation Report of the Bank of England. This always had its own significance in terms of forecasts and the views which they implied but the new Governor of the Bank of England has stepped up its importance. Not only did his announced policy of Forward Guidance come at an Inflation Report rather than at an official Monetary Policy Committee meeting but the implications of it made quite a few MPC meetings effectively redundant! After all once you have announced that interest-rates will be lower for longer the only real decision at MPC meetings became whether they might cut interest-rates further. As we have been in a mini-boom even they have balked at that so the meetings have been relegated to sampling the delights of the Bank of England tea trolley.
What did Forward Guidance do for us in the war daddy?
Here we have an immediate problem which is illustrated by taking a look at the Forward Guidance announcement.
In particular, the MPC intends not to raise Bank Rate from its current level of 0.5% at least until the Labour Force Survey headline measure of the unemployment rate has fallen to a threshold of 7%, subject to the conditions below.
If we go back to August 7th last year when this was announced the fact was that nobody expected the Bank of England to raise interest-rates anyway. Indeed only two months before the MPC had three members who wanted to loosen monetary policy there and then.
Three members of the Committee (the Governor, Paul Fisher and David Miles) voted against the proposition, preferring to increase the size of the asset purchase programme by a further £25 billion to a total of £400 billion.
If we put to one side the issue that the boom in the UK economy proved those three individual’s to be completely wrong (again) we note that compared to this Forward Guidance was in fact a tightening of policy. Or to be more specific less loose. Rather than plans for more Quantitative Easing from a substantial MPC minority we got instead open mouth operations or hot air if you prefer. This was in marked contrast to the expectations of many before Mark Carney took up the role.
The Dark Side
This view has been behind my dark side analysis of Forward Guidance where UK monetary policy was set by markets. One which has unambiguously helped to tighten monetary policy has been the rise of the pound sterling on the foreign exchanges. If we take the old Bank of England rule for such matters then the rise has been equivalent to a base rate rise of the order of 1.25%. One factor in this has been the rise against the US Dollar from US $1.54 to over US $1.64 as I type this.
This rally has had quite a strong anti-inflationary effect. For example in the month before Forward Guidance was announced the price of a barrel of Brent Crude rose from £70.96 in July to £71.62 in August (Index Mundi figures), but it then fell and as I type this it is now £66.25. Compared to a year ago the effect is even stronger as February 2013 was a recent peak in the price cycle with the price of a barrel of Brent Crude oil averaging £75.24. On this road we have seen fuel prices at the pump drop too with both unleaded petrol and diesel some 6 pence per litre cheaper than a year ago.
We get a similar pattern from expectations of UK interest-rates where confusingly the futures market contract is called short sterling. Back on August 8th I pointed out that the June 2016 contract had closed at 98.42 the day before and had risen to 98.56 pre the Forward Guidance announcement on expectations of an easing of policy such as more QE. As I type this it is now at 98.06 so expectations of interest-rates then have risen from 1.58% to 1.94%. A similar theme has been at play in the UK Gilt or government bond market. Back then the ten-year benchmark yield was jsut below 2.5% but is now 2.76% having pushed above 3% briefly a while back.
The only loosening of policy was a relic of the Mervyn King era which was the Funding for (mortgage) Lending Scheme. This led to mortgage rates falling over this period as the lifetime tracker measured by the Bank of England fell from 3.26% in August to 2.92% in January. Although of course Mark Carney has now scrapped many of the incentives in this area.
Forecasting
This has been a running theme for this blog where the Bank of England has consistently predicted where the UK economy will not be! In general it has under predicted inflation and over predicted economic growth. This time around the problem is in the area of unemployment where it set a target for the unemployment rate which it forecast would be achieved in 2016. Or to put it in Star Wars terms a time “far,far,away”. However here is the new forecast.
The LFS headline unemployment rate is likely to reach the MPC’s 7% threshold by the spring of this year
The Bank of England has had some spectacular forecasting failures over the credit crunch era as for example it expecting inflation to be on target when instead it surged above 5%. But especially considering that the unemployment rate was set as a target this has gone wrong on as large a scale and as fast as anything that preceded it. For example the medium term appears to have lasted only about six months!
Even Mark Carney admits this as whilst he introduced the eighteen new variables that the Bank of England will forecast he said that it will probably forecast them incorrectly. However like being England cricket captain the pressure of the job invariably gets to people as Mark Carney followed this up later by contradicting himself in the way that his predecessor Mervyn King did reguarly.
unemployment is the right metric and it worked
Really Mark? How?
Forward Guidance Mark Two
Apparently the first version has been so successful it is to be immediately abandoned! It is being replaced by something so vacuous that it cannot go wrong. If you add eighteen new metrics to a system there is bound to be something you can hang your hat on. Rather ironically this seems to involve the original inflation target as Mark Carney does what Elvis Presley described as this.
Bright in early next morning
it came right back to me.
Here are the details.
The MPC sets policy to achieve the 2% inflation target, and, subject to that, to support the Government’s economic policies, including those for growth and employment.
So as the unemployment rate target morphs back to the original inflation target we are reminded of this from Kylie.
I’m spinning around, move out of my way
Indeed if we look at matters we see that UK monetary policy has returned to its original setting as a familiar friend has returned. The emphasis is mine.
Despite the sharp fall in unemployment, there remains scope to absorb spare capacity further before raising Bank Rate.
This is of course the output gap. We see here an admittal of the fact that the output gap has been discredited by the fact it has been renamed a bit like the way the Windscale nuclear reprocessing plant was called Sellafield. Same reality but different name. I have been a consistent critic of the application of the output gap to the UK economy over the credit crunch period as its performance if we are being polite has been hopeless. But you do not have to take my word for it as here it is from the original Forward Guidance document.
But the large degree of uncertainty surrounding the evolution of the supply capacity of the economy makes the output gap a less desirable indicator at present…….In addition to these complications, the output gap does not perform well from a data or communications point of view. The output gap is unobservable and difficult to explain, and any estimate would be subject to substantial uncertainty. That would make it hard for the public to understand the guidance.
Apparently all that has been solved since August, or perhaps not.
Comment
If today’s press conference was any guide the honeymoon period of the new Bank of England Governor is most definitely over. I note also that he was keen to involve his colleagues or if you prefer staff to deflect some of the flak and so that they took some of the blame. I guess they must now regret their road to Damascus conversion back on August 7th 2013 when they all shouted “Me too Sir!”
If we look beneath to where monetary policy stands in the UK it has returned after a six month break to the metrics that were used by the previous Governor Mervyn King. The language has changed as output gap is now called spare capacity but the principle is the same. So far Mark Carney has been a lucky Governor as an economic recovery has been combined with an anti-inflationary rise in the pound. Is today a signal that his luck may be turning?
For those looking for a view on interest-rates here it is.
Despite the sharp fall in unemployment, there remains scope to absorb spare capacity further before raising Bank Rate.When Bank Rate does begin to rise, the appropriate path so as to eliminate slack over the next two to three years and keep inflation close to the target is expected to be gradual.Even when the economy has returned to normal levels of capacity and inflation is close to the target, the appropriate level of Bank Rate is likely to be materially below the 5% level set on average by the Committee prior to the financial crisis.
So do not hold your breath is the message and it will not be much when/if it happens.
via:http://www.mindfulmoney.co.uk/wp/shaun-richards/mark-carneys-honeymoon-period-is-over-as-forward-guidance-is-rebooted-lets-hope-his-luck-isnt/
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