Carney Fight Against Higher Rates Helped by Inflation

Bank of England Governor Mark Carney has won respite in his battle to keep a lid on interest rates after inflation slowed to the 2 percent target for the first time in four years.

With unemployment falling faster than the BOE anticipated, Carney can look to yesterday’s inflation data for comfort as he reinforces his message that it’s not time to raise borrowing costs. Those figures will aid the governor when he presents new forecasts for growth and inflation next month.

“We know he wants to keep rates low,” said George Buckley, chief U.K. economist at Deutsche Bank AG in London. “Letting guidance lapse would go against everything that Carney has said since he’s become governor.”

The slowdown in price growth is adding to Carney’s good fortune since he took over the BOE from Mervyn King in July. In addition to seeing a double-dip recession revised away and the economy revive at a surprisingly fast pace, hitting the inflation goal brings the new governor a victory that eluded King for most of his second term in charge.

The pace of the recovery is pushing unemployment closer to the 7 percent threshold set by Carney as the point for considering an interest-rate increase. While the BOE forecasts it may fall to the key level as early as the end of 2014, some economists say it will happen mid-year. Unemployment was 7.4 percent in the three months through October.

Inflation Joy

With the threshold nearing, Deutsche Bank and Coutts & Co. are among those who say Carney may refine guidance to maintain his loose-policy stance. Easing price growth gives him more room for maneuver to adapt the plan. It also means there’s less chance that it will breach one of the two inflation clauses that would void guidance.

Barclays Plc lowered its forecast for 2014 inflation after yesterday’s data, saying price growth will average 1.8 percent. That compares with a previous projection of 2 percent. The median estimate in a Bloomberg survey is 2.2 percent.

“It’s a like a ‘get out of jail free’ card,” said Rob Wood, an economist at Berenberg Bank in London who previously worked at the BOE. “If inflation had been above 2.5 percent and they were close to hitting 7 percent unemployment, I think they would be facing a lot more pressure to raise rates this year. As it is, inflation remains subdued, wage growth remains pretty low, so it doesn’t look like there’s any urgent need.”

Carney is due to address lawmakers in the U.K. Parliament today on financial stability, which is the third clause in guidance. He will speak at 2:15 p.m. London time.

Price Shocks

Britain’s inflation rate rose above the BOE’s goal in December 2009 and stayed above that level until last month, once reaching 5.2 percent. Under King, the majority of the Monetary Policy Committee argued it would look through one-time price shocks and that the economy wasn’t strong enough to withstand tighter policy.

Now that the economy is improving, Carney has said it’s right to keep the BOE’s key rate at a record-low 0.5 percent because the recovery needs to be sustained.

Modifications to forward guidance might come as soon as February, when the MPC publishes new forecasts and Carney holds his quarterly Inflation Report press conference.

Options for policy makers include reducing the threshold, emphasizing that 7 percent isn’t a trigger, or stressing other parts of the economy that need to improve before rate increases will be considered, said Jonathan Ashworth, an economist at Morgan Stanley in London.

Another possibility would be the model used by Sweden’s Riksbank, which publishes an outlook for the likely path of its benchmark rate.

Guiding Pioneer

While Carney was a pioneer of guidance as governor of the Bank of Canada, subsequent converts have moved ahead of him in terms of fine-tuning the policy where needed.

The Federal Reserve, which has a jobless threshold of 6.5 percent, tweaked its language in December and pledged not to raise the main interest rate until “well past the time” unemployment falls below that level. European Central Bank President Mario Draghi said last week he’s using “firmer words” to stress a commitment to low rates.

Minutes of the Fed’s December meeting released last week showed that officials discussed and rejected the idea of lowering their unemployment threshold, opting instead to “provide qualitative guidance regarding the committee’s likely behavior after a threshold was crossed.”

“All evidence suggests the BOE are desperate to have rates ultra low for some time,” said Alan Higgins, U.K. chief investment officer for Coutts & Co. in London. “What you’ll see is even stronger, Fed-type language stating that its highly likely that we won’t raise rates even if we go through 7 percent.”

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