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:
- Third quarter economic growth was 0.8%, more than some forecasters (including the Office for Budget Responsibility) had earlier pencilled in for the whole year.
- The latest inflation numbers (for October) showed an unexpectedly sharp drop. The annual increase in the Consumer Prices Index (CPI) fell by 0.5%, bringing it to 2.2%, only marginally above the Bank’s regularly missed 2% target.
- The unemployment rate has declined to 7.6%.
- Government borrowing from April to October 2013 was 8.2% lower than for the same period in 2012.
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.