Bank of England's Caution Is Justified. What Happens When It Isn't?

The textbooks would say to raise interest rates. Mark Carney is going off script.

Mark Carney, Britain's "unreliable boyfriend," will have a chance to prove himself.

Photographer: Chris J Ratcliffe

Britain's labor market is powering ahead, and inflation exceeds the Bank of England's target. Is it hot in here? Don't expect Governor Mark Carney to cool things off.

Here's a major economy where price increases have not only picked up, but at 2.6 percent easily top the 2 percent target. Unlike in the U.S., the euro zone and Japan, a strong job picture is accompanied by inflation that would, according to textbooks, provide a great rationale for increasing interest rates.

Yet there's little appetite at the central bank to do that. At their August meeting, only two of eight policy makers voted to tighten credit. At a conference in Portugal at the end of June, Carney was thought to be warning of an impending move. That has not materialized.

The bank's hesitation made Carney an easy target for critics who claim he again walked up to the line and backed away. He's once again being mocked for his mixed messages and lack of follow-through -- like an "unreliable boyfriend," in the 2014 taunt from Pat McFadden of the House of Commons Treasury Select Committee. There's a risk that the epithet could become his epitaph. 

Is the taunt justified? More importantly, is the textbook case for a rate increase really justified by not just the economic numbers, but also the velocity of the change in the numbers? How should the central bank consider the reasons the numbers look the way they do?

Britain's unemployment rate fell to 4.4 percent last quarter, the lowest since 1975, the Office of National Statistics said this week. Brexit was supposed to presage economic catastrophe. We aren't seeing it in the employment data.

Look a little closer, though, and some of the sheen comes off. The same figures also show wages rose at an annual pace of 2.1 percent. With inflation at 2.6 percent, workers not only aren't pocketing the gains, but are in fact paying for the gains out of their own pockets. 

For officials sitting around the table at the BOE, that doesn't look great for consumer spending, the lifeblood of Britain's economy. Then there is inflation itself, which has been rising steadily since the vote last summer to leave the European Union. Carney & Co. caught a break when the government also reported this week that consumer price gains were steady at 2.6 percent. In other words: above target but not spiraling out of control.

The reason inflation is above target is getting some scrutiny at the bank. There's a view that it's solely a result of the slide in the pound that followed the Brexit vote. If that's true, a rate increase is not yet entirely warranted, and could hurt domestic economic behavior. 

For all his signaling challenges, Carney has consistently been the adult in the room during these trying times in U.K. politics and policy. His allies say that anyone grading Carney should watch BOE actions and their results -- not engage in central bank Kremlinology.

Fair enough. The question, then, is what will happen when a rate increase truly is needed. Will the boyfriend prove reliable?

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

    To contact the author of this story:
    Daniel Moss at dmoss@bloomberg.net

    To contact the editor responsible for this story:
    Philip Gray at philipgray@bloomberg.net

    Before it's here, it's on the Bloomberg Terminal.