As the newly installed central bank chief defends his view of gradually falling unemployment and benign inflation in the face of resurgent economy, his task is being made harder by a legacy of errors in BOE predictons for growth and prices.
Those misfirings have left investors with more reason to doubt the policy parameters set by the BOE, which Carney took over in July. With the recovery building momentum, suspicion the unemployment rate will fall faster than the BOE projects, or that inflation will prove more aggressive, has led investors to increase bets officials will raise the benchmark rate earlier than Carney has indicated and driven 10-year gilt yields to the highest since 2011.
“The Bank of England’s forecasts are lacking credibility when the market is looking at developments in the labor market,” said Philip Rush, U.K. economist at Nomura International Plc in London. “The market is taking a materially different view and doesn’t feel much pressure to change that on the basis of the bank’s own forecast record.”
Investors are pricing in an increase in interest rates as early as 2015 even as the U.K. central bank says it will leave the benchmark at 0.5 percent at least until unemployment falls to 7 percent from 7.7 percent so long as inflation remains in check. Its economists don’t see the jobless threshold being breached until late-2016.
The 10-year gilt yield, which rose to 3 percent yesterday after minutes showed Bank of England officials saw no need for additional monetary stimulus, retreated in London today after Federal Reserve policy makers unexpectedly refrained from paring their $85 billion of monthly bond purchases.
The yield was down 14 basis points at 2.87 percent as of 10:40 a.m., leaving the spread over similar-maturity German bunds at 96 basis points. The implied rate on short-sterling futures contracts maturing in December 2014 fell to 0.87 percent today from 1 percent yesterday. The rate is up from 0.68 percent on Aug. 1.
On inflation, which the BOE is charged with keeping at 2 percent in the medium term, the bank’s November projections for the fourth quarter of the following year fell short in each of the past eight years by an average of almost a percentage point. In November 2009, it predicted consumer-price growth a year later would be 1.6 percent. It turned out to be 3.4 percent.
Inflation hasn’t been below the bank’s target since November 2009 and even when it reached 5.2 percent in September 2011, then Governor Mervyn King was predicting its return to 2 percent within two years. It stood at 2.7 percent last month.
As for growth, the BOE overestimated it each November in six of the past eight years. The error has been most pronounced since the financial crisis, with the BOE misjudging gross domestic product by more than 4 percentage points on average in 2008 and 2009 and by 1.6 points in the following three years.
“If every forecast they had published was accurate, their view on unemployment would have more credibility,” said John Wraith, a fixed-income strategist at Bank of America Corp. in London. The fact they’ve been poor forecasters will “dampen the impact” of the so-called forward guidance, he said.
Unemployment has often fallen faster in two years than the BOE anticipates it will in three, said George Buckley, chief U.K. economist at Deutsche Bank AG.
Investors are also signaling they believe economic growth will outpace the 0.6 percent quarterly rate the bank projects and that productivity may prove weaker than the bank estimates. Both suggest companies will find themselves having to hire.
“All of those things are reasons markets are skeptical about the speed at which unemployment falls,” said Buckley.
Another issue is the so-called inflation knockout. Central bankers say they will rethink their guidance if they decide medium-term inflation is likely to breach 2.5 percent or price expectations are no longer well-anchored.
“The Monetary Policy Committee, like most others, has had a poor forecasting record of inflation and been repeatedly surprised on the upside,” said Vicky Redwood, an economist at Capital Economics Ltd. and formerly at the Bank of England. “So you can see why markets will be sceptical inflation will be close to the target in two years.”
The BOE is not alone in misreading the outlook as the collapse of Lehman Brothers Holdings Inc. plunged the global economy into recession. In late 2008 as the crisis raged, the International Monetary Fund predicted the U.K. economy would contract by little more than 0.1 percent the following year. It shrank by 5.2 percent.
The central bank is alert to its past weaknesses. In May, it said it will continually review its forecasting framework after an independent review conducted last year by former Federal Reserve official David Stockton concluded its forecasting capabilities had deteriorated in the previous five years, resulting in “large” errors. The report also said the BOE was “marginally worse” than outside forecasters.
Carney told lawmakers last week that differences in opinion over the economic outlook are “natural,” while contending his guidance is reinforcing recovery and the likelihood is that unemployment will be slow to decline. The bank’s forecasting capability has improved, he added.
Other central banks too are struggling to bring investors into line with its thinking. The Fed, the European Central Bank and Sweden’s Riksbank have adopted or augmented forward guidance strategies in the last year, only for bond yields to climb as growth strengthened.
“The only reason guidance can be powerful is if you believe central bank forecasts are better than anyone else’s,” said Jim O’Neill, former chief economist at Goldman Sachs Group Inc. “But they’re just human, no better at economic forecasting than anyone else.”
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