"Birds flying high you know how I feel, Sun in the sky you know how I feel, breeze driftin' on by you know how I feel, It's a new dawn, It's a new day, It's a new life and I'm feeling.......... mildly optimistic"
Well, she didn't quite finish like that, but if she was writing that song in the UK at the moment she might prefer my altered version.
Wednesday marked a new dawn for monetary policy in the UK with the formal introduction of forward guidance as part of the monthly inflation report. I've covered my thoughts on forward guidance being a positive progression before so now it's in place I thought it would be useful to have a quick look at what the policy is.
In brief the BoE has now indicated it is going to tie it's monetary policy to the level of unemployment in the UK in addition to targeting inflation, but with the emphasis being that inflation must remain under control first and foremost.
In the words of the Bank of England (MPC by the way stands for Monetary Policy Committee of the BoE - those that decide these things!)
"In particular, the MPC intends not to raise Bank Rate from its current level of 0.5% at least until the Labour Force Survey headline measure of the unemployment rate has fallen to a threshold of 7%, subject to the conditions below.
The caveat for all of this is inflation and the markets.
Inflation in the UK is currently around the 2.9% mark. The target level for inflation is required to be around 2%, although it's rarely been at that level for quite some time. The BoE has predicted that inflation will likely remain roughly at about 2.5% for the next 18-24 months, however their reputation in accurately predicting this has been relatively unsuccessful. They are likely to accept a level of inflation which stays roughly at the current level. If however inflation starts to increase even more, then they could look to reduce their asset holdings, or increase rates, to control inflation before unemployment is near breaking below that 7% level.
With the financial stability indicator it is a lot more vague as to what might cause the BoE to adjust it's forward guidance stance. The only indication is a point when "the Financial Policy Committee (FPC) judges that the stance of monetary policy poses a significant threat to financial stability that cannot be contained by the substantial range of mitigating policy actions available to the FPC". What these financial stability indicators are could include a large list of issues - over spiraling house prices, a devaluation in the pound to a non-beneficial level - the list could be endless, but the BoE doesn't specify.
In addition to all of this, the BoE signed off their statement indicating that even if these "knockouts" (consistent high inflation breaches or financial instability) were reached this doesn't necessarily mean they'll reverse course.
So far so hazy! If compared to the Fed's attempts at forward guidance a couple of months ago it seems a lot less clear cut. But then maybe, wary of the way the market reacted to the Fed trying to give a clear positive picture, the BoE felt the need to reassure markets that nothing was set in stone. The timelines given by Mark Carney for UK improvement were also on the more pessimistic side compared to the US, which potentially emphasises the need for more caution in their guidance. UK unemployment currently sits at 7.8%. The medium term equilibrium rate for unemployment in the UK is estimated at being around 6.5%. But the BoE suggests that unemployment won't get towards the 7% threshold until 2016, indicating interest rates to remain low, and QE to remain in place, for a further 2.5 to 3 years - a full year and a half beyond the Fed's estimates for the US.
These timelines don't particularly inspire reason for optimism. But these are perhaps the safest estimates for them to give based on their projections and will of course be subject to change if things improve more rapidly. I think it is better to give a more leveled outlook on this rather than promote over exuberance and over optimism by making people think the rate will be increased earlier, if they don't believe it to be so. If that 7% threshold is met within the next year, then the BoE will act earlier in order to reduce QE and begin raising rates. There has already been positive signs for the UK Economy over the last few months with growth (although small) over the last 2 quarters and other key indicators showing things are gradually improving (despite the negative spin the BBC might always try and use!). So I think there is reason for optimism, we just have to be realistic that this is just the start and things will hopefully slowly take shape, even if it isn't as quick as the US, it's almost certainly going to be quicker than Europe.
As for Mark Carney's first foray into forward guidance in the UK. We now have further clarity over what the Bank of England is going to be looking to when it is deciding monetary policy. We have a clearer unemployment rate, which is published each month for all to see, as well as the previously known target level of inflation. All in all it helps both the market and the individual to better plan for the future, which is a good thing. Everything is always subject to change in life, but at least the parts of the puzzle which help determine where interest rates are going to go is more visible. The first level of forward guidance whilst providing clarity in terms of observable levels has though left some uncertainty as to when the Bank might have to sway away from their current projections, so maybe in time more clarity around this aspect would be helpful.
I found out last week that the nickname for the Canadian dollar is "the Loonie". The Canadian at the head of the BoE will be striving to ensure the English press don't christen him similarly. He's made a good start, so for now he'll be alright, but if there's too much increase in the haziness they might just be tempted!
Have a good weekend!
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| The Loonie, not to be confused with....... |
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| ......the Loony |
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