BOE Guidance Backed by McCafferty Citing ‘Feeble’ InvestmentJennifer Ryan and Scott Hamilton
Bank of England policy maker Ian McCafferty said business investment has been “feeble” and won’t pick up until the end of the year, underlining the case for officials to keep their key interest rate at a record low.
In a speech late yesterday, he said the BOE sees no “immediate need” to increase borrowing costs even when unemployment falls to 7 percent, echoing language used by policy makers in the minutes of their January meeting. Data yesterday showed the jobless rate fell to 7.1 percent in the three months through November, just above the threshold officials have set as a point to review its benchmark rate.
“A recovery in business investment is a precondition for a sustained wider recovery,” McCafferty said at Nottingham Business School in central England. “I suspect that this may still be a little time in coming, and that more rapid investment growth may not show through until later this year and into 2015.”
The pace of the drop in unemployment has prompted speculation that BOE Governor Mark Carney will refine guidance next month, with some economists forecasting he will lower the threshold. McCafferty said officials “will say more” on the policy outlook once the 7 percent level is reached.
At that point, officials will start a “fundamental consideration of the amount of slack and the fundamental performance of the economy and what we have learned over the course of the period of guidance,” McCafferty told reporters after the event. “We will be starting that internal review and set of discussions, and once that is completed we will be able to say more in detail about where we will be going.”
The share of long-term unemployed rejoining the workforce is higher than typical at this point in the economic cycle, McCafferty said. That suggests the U.K. unemployment rate may be able to fall further without putting pressure on pay.
“The equilibrium neutral rate of unemployment may be coming down as we speak,” he said. “So even if unemployment is coming down rapidly, it may not be closing the gap between where we are now and the neutral rate of unemployment quite as rapidly as you might fear.”
In his speech, McCafferty also said the economic rebound is in its early stages. With headwinds to a broader pickup likely to persist, “when the time does come to reduce the current degree of stimulus, it would be appropriate to do so only gradually,” he said.
Officials are also monitoring changes in the exchange rate, and “sharp movements” are “always a concern,” he said. Sterling climbed to a one-year high against the euro yesterday after the unemployment rate fell faster than economists had forecast.
“If it rose sharply from here it’s something that we will study further,” he said. “It’s still trading at the top of the range after the depreciation in 2007. It’s still competitive.”
McCafferty and his colleagues on the MPC are trying to push back against investor expectations for higher interest rates. Carney is due to address an audience at the World Economic Forum annual meeting in Davos, Switzerland, this week. Short-sterling futures fell yesterday, a sign investors added to bets for higher borrowing costs. The implied yield on the contract expiring in March 2015 rose nine basis points to 1.10 percent.
Recoveries in business investment typically lag household consumption, McCafferty said. In the current cycle, the delay may be longer than normal, reflecting the shock to demand and the persistent uncertainty on the outlook.
McCafferty said the conditions for an investment recovery are “finally falling in place,” including an improvement in credit conditions.
“Funding, both internal and external, has become more readily available, uncertainty about future demand has fallen and confidence about the economic outlook more generally has picked up,” he said.
Bank loans remain an important source of finance and the BOE’s Funding for Lending program will continue to provide support, McCafferty said. In addition, an increase in bond yields will provide “welcome relief” on pension deficits, giving companies burdened with a shortfall breathing room to invest.
“We now appear close to the point at which additional investment will be required to cope with future increases in demand,” he said. “Rising business investment should help restore productivity growth amongst the labor force, leading to higher real wages and more sustainable growth in consumption. That is the definition of a sustainable recovery.”