Bank of England plays down faster fall in unemployment says Capital Economics


The latest Inflation Report from the Bank of england has provided "some sort of superficial support" for the notion that interest rates could rise sooner than has been expected, But research consultancy Capital Economics says that the disinflationary effects of spare capacity in the economy will "keep rates on hold for longer than markets anticipate."

Carney went out of his way to stress that the Bank's seven per cent unemployment threshold is only a "way station" at which the Monetary Policy Committee (MPC) will re-assess its policy stance, not an automatic trigger for a rate hike, says chief European Economist Jonathan Loynes.

It's perhaps more relevant, he continues, that the MPC's GDP growth forecasts has moved expectations for the unemployment rate down, which means that, on the basis of current market expectations for interest rates, the threshold will be reached in the third quarter of 2015. This morning, the MPC said there is a two in five chance of the employment threshold being met in the fourth quarter of 2014.

The report's assessment of "knock-outs" to forward guidance provides, says Loynes, some reassurance as the MPC's forecast for CPI was revised down compared to November. This, he explains, "implies a reduced risk (of 1 in 3) that inflation would be above the 2.5 per cent knock-out threshold at the relevant 18 to 24 month horizon. At the same time, the assessment on inflation expectations and the risk of financial instability were sanguine."

Capital Economics retains its view that interest rates will remain "on hold rather longer than the markets expect as the effects of the large amount of spare capacity in the economy keep inflation low." But, it adds, it fears that Carney and his colleagues have a job and a half to do when it comes to stopping interest rates from rising further - "with potentially adverse effects on the economic recovery - if unemployment remains on its recent downward trend."