Interest rates could go up sooner than you think
Mark Carney today made it clear the Bank of England will not raise rates just because unemployment is diving and growth is booming.
But although markets expect the first rate hike in about two years, it could come even sooner – and a graph buried in the middle of the Inflation Report shows why.
Instead of looking at unemployment alone, the Bank is looking at the output gap – the gap between the size of the economy now and where the Bank thinks it could be, without raising price pressures.
In fact Carney will consider a range of proxies, since the gap is notoriously hard to measure.
These proxies include wage growth, labour market participation, the numbers working part time only because they cannot find a full time job, and firms’ estimates of their spare capacity.
Currently the Bank believes most of this slack is in the labour market.
When the monetary policy committee thinks the gap is about to disappear, they will slowly start raising interest rates – too soon and the Bank fears growth will be stifled, too late and inflation will rise.
However, the Bank already estimates the output gap is pretty small, at about 1.5 per cent.
And this chart from the Inflation Report shows most of the slack in the labour market had already disappeared over the last year.
So just as plunging unemployment forced the Bank to update its August 2013 guidance more than two years sooner than initially expected, so the MPC could have to act faster than it currently believes.
Carney may be worried that the recovery is still fragile, based too much on consumer spending and on the housing market.
But his latest guidance showing a slow run up to rate hikes could come to an end sooner than markets think.