THERE was little of significance from the Bank of England’s meeting last week, except for a small statement guiding us towards this week’s inflation report. But tomorrow’s quarterly forecast will be overshadowed by a decision about forward guidance.
In July, the Bank’s Monetary Policy Committee (MPC) said rises in market rate expectations were unwarranted – a statement some described as “guidance lite,” but which the Bank went to great lengths to say was not. So should they go the whole hog now, and under what criteria?
The European Central Bank shows us how difficult it can be. Its president Mario Draghi deliberately made no mention of dates or thresholds, which begs the question: how much weight does such guidance have? Monument Securities has alluded to it being a confidence trick.
The MPC will want to avoid that, so may decide against doing anything – although this risks disappointing investors. If they do proceed, many believe linking low rates to a threshold of unemployment, as in the US, will be the most likely path. In doing so, the bank would also have to argue that to get unemployment down, it would take a more tolerant view towards its 2 per cent inflation target.
Some, like Capital Economics, suggest the MPC could go further and make its inflation condition even looser. It has, after all, kept rates low despite expecting inflation to be 0.5 percentage points above target in two years’ time. But if this does happen, and the 2 per cent inflation target is subordinated to whatever target is chosen, Monument Securities and others in the City would argue it’s the end of inflation targeting and possibly of price stability.
In the short term, that might not make much difference, as markets currently don’t expect the first rate rise until the end of 2015. But new governor Mark Carney would also hope this message gets out to the wider public, engineering a confidence that rates won’t rise even if the recovery picks up.
This could, however, be where the greatest risk lies. For if he succeeds, households may borrow plenty more – but then what happens if the Bank has to quickly raise rates for external reasons? That public would rightly feel it had been duped, and with its finances affected, the political fallout could be messy.
On the face of it, forward guidance looks relatively simple. In reality, it is anything but.
Ross Westgate co-presents CNBC’s Worldwide Exchange. Follow him on Twitter @rosswestgate