Carney Links Rates to Jobless to Stem Interest-Rate BetsScott Hamilton
Bank of England Governor Mark Carney linked the monetary policy outlook to unemployment for the first time as he tried to quell investor bets on higher interest rates.
A month after the central bank said that financial-market expectations on an interest-rate increase were “not warranted,” Carney said officials are unlikely to tighten policy as long as unemployment exceeds 7 percent. At the same time, he reserved the right to drop that guidance should inflation expectations get out of control. The key rate is currently at a record-low 0.5 percent.
Britain’s jobless rate was at 7.8 percent in the quarter through May and the BOE sees it staying above 7 percent at least until the third quarter of 2016, implying no change to policy for three years. Investors drove up the pound, gilt yields and rates on three-month futures contracts settling after June 2015.
“It’s a very weak form of forward guidance, subject to so many conditions, so many get-out-clauses,” said Ned Rumpeltin, head of Group of 10 currency strategy at Standard Chartered Plc in London. “They are going to have to work harder to change market expectations of rates sooner if we see improvements” in the economy.
The pound fell to as low as $1.5206 immediately after the guidance report was published before rebounding. It rose 0.9 percent to $1.5481 as of 2:50 p.m. London time, the highest in almost seven weeks. Ten-year bond yields increased 4 basis points to 2.51 percent, the highest since June.
The U.K. central bank said that the unemployment level is a threshold, not a “trigger,” and will provide a point at which the MPC will reassess its policy stance.
Officials said they are ready to expand their bond-purchase program again if needed. They also plan not to unwind quantitative easing and will reinvest any cash flows from maturing gilts in the 375 billion-pound ($574 billion) pile.
“We are not at escape velocity,” Carney said as he presented his first quarterly forecasts as governor. “Until the unemployment threshold is reached, the MPC intends not to reduce the stock of asset purchases.”
The shift to thresholds represents another innovation at the BOE by Carney after he began guiding investors on policy last month, just a week after taking over from Mervyn King. With the economy showing signs of strengthening, the central bank said the new tactic should reduce the risk of a “premature” increase in short-term rates and help to secure the recovery.
As Bank of Canada governor, Carney introduced time-contingent guidance in 2009, pledging to keep the key rate at a record low until mid-2010. He dropped that commitment in April 2010 as the economy improved. The BOE said today that linking guidance to economic developments rather than a time period will make it “more effective.”
The U.K. central bank said its guidance program is subject to caveats, including two related to price stability.
The first is if the MPC judges it “more likely than not” that inflation will be 0.5 percentage point above its 2 percent goal in 18-24 months. The second is if the MPC judges that medium-term inflation expectations “no longer remain sufficiently well anchored.” The third is if the Financial Policy Committee judges that the current monetary policy stance poses a “significant threat to financial stability.”
“What the markets were not prepared for was the ‘get out’ clauses,” Lena Komileva, chief economist at G+ Economics in London, said in an e-mailed note. “In effect, the markets have taken the view that the inflation conditionality that can suspend the bank’s forward guidance dilutes the effectiveness of the bank’s pre-commitment to keeping low rates for longer.”
Investors raised their bets on interest-rate increases after Carney spoke, signaling they expect inflation concerns to trump the bank’s new unemployment threshold. The implied yield on sterling futures contracts expiring in September 2016 rose 10 basis points to 1.90 percent today.
“The knockouts are probably stronger than anticipated,” said Sam Hill, a gilt strategist at RBC Capital Markets in London.
On the economy, the central bank sees it growing 0.5 percent this quarter after expanding 0.6 percent in the previous three months. It raised its 2013 and 2014 gross domestic product growth projections to 1.5 percent and 2.7 percent from 1.2 percent and 1.9 percent in May.
While a recovery “appears to be taking hold” in the U.K., it will remain weak by historical standards and GDP won’t reach its pre-crisis peak for another year, the BOE said. Given that outlook, it’s appropriate to bring inflation back to target at a slower than normal pace, according to the central bank.
The BOE sees inflation cooling gradually from 2.9 percent in June and reaching 2 percent around the fourth quarter of 2015. That outlook is based on the benchmark rate staying at 0.5 percent and QE unchanged.
Officials said there may be times when it will be faced with a “trade-off” between economic growth and inflation, and that its remit allows it to “extend or reduce” the period in which it intends to reach the price target.
“Our aim is to help secure the recovery, while ensuring that risks to price stability and financial stability are well contained,” Carney said.
The BOE policy announced today echoes the Federal Reserve. It began using thresholds in December, when it said interest rates will stay low “at least as long” as unemployment remains above 6.5 percent and if inflation “between one and two years ahead” is projected to be no more than 2.5 percent.
The BOE said that if the threshold or a knockout is breached, this doesn’t imply an automatic interest-rate increase.
“The action taken by the committee would depend on its assessment of the appropriate setting of monetary policy required to fulfill its remit to price stability,” it said.
The BOE noted that short-term interest rates had risen since May and this implied a faster withdrawal of stimulus than was likely given the economic outlook. In the run-up to its Aug. 1 policy meeting, at which guidance was agreed, investor expectations were for a rate increase in late 2015. That compared with a May forecast for late 2016, the BOE said.
“This experiment will be interesting,” said Neil Williams, chief economist at Hermes Fund Managers Ltd. in London. “It remains to be seen whether forward guidance ends up being more cosmetic than real, with little added impetus to growth.”