Forward Guidance Goes Backwards

The Bank of England has been revising its forecasts

In November the Bank of England published its latest Quarterly Inflation Report (QIR).  This report had been more eagerly awaited than many of its predecessors because of the Bank’s introduction of ‘forward guidance’ on interest rates in early August.

Back then, Mark Carney, the Bank’s newly imported Governor, suggested that base rate was unlikely to be reviewed until the unemployment rate fell to 7%, which was projected to be not until at least the middle of 2016. The markets were not convinced and the Bank found itself firmly on the back foot, defending its pessimistic view that it would take over two and a half years for unemployment to drop by 0.8%.

Since August, news on the UK economy has been generally upbeat:

In its November QIR, the Bank effectively conceded that its summer view had been too gloomy. In its introduction the Bank said “In the United Kingdom, recovery has finally taken hold. The economy is growing robustly as lifting uncertainty and thawing credit conditions start to unlock pent-up demand.” It went on to concede that there is now “a two-in-five chance” its 7% unemployment threshold will be reached by the end of 2014.

Hitting 7% does not mean rates will rise, the Bank stresses. It is merely the trigger for a review and if other factors are benign the 0.5% base rate could continue. The stimulation that theoretically provides is still relevant: in inflation-adjusted terms the UK economy is still 2.5% smaller than it was in the first quarter of 2008. Nevertheless, the markets continue to be sceptical, witness the Bank’s own graph showing market-derived future interest rates.

Chart forecasting the Bank of England Base Rate