Let’s start with the good news. The economy is recovering more convincingly than at any point since the financial crisis of 2008. And while this is hardly new news (the figures have been pointing that way for a while) the Bank of England seemed to confirm it today as it raised its growth forecast for both this year and next year. If its predictions are borne out, next year the economy will expand by 2.8% – the highest rate since 2007.
In fact, this isn’t the end of the good news. Inflation is lower than expected; unemployment is also falling faster. Almost any metric you care to look at suggests that this is turning into a benign and pretty solid recovery. Let’s leave aside for the moment the question of why it’s taken so long, and why that growth is uncomfortably reliant on consumer debt.
The big question, however, is what the Bank of England does next. Not only are interest rates down at 0.5% – the lowest level on record – the Bank’s new Governor, Mark Carney, committed earlier this year not to raise them until unemployment dropped beneath 7%. Forward guidance, as the Bank calls it, is best regarded as a set of self-imposed handcuffs. Until the jobless rates drops beneath that magic number seven, the handcuffs stay on and rates don’t go up.
And what we learnt from the Bank’s Inflation Report today is that the handcuffs are likely to come off a lot sooner than had been expected. Back in August the Bank didn’t expect the unemployment rate to drop beneath 7% until at least the end of 2016. Today it revealed it now believes unemployment will drop beneath this level at the end of 2014. That’s a pretty big adjustment.
There are a few obvious implications. One is that the Bank’s Monetary Policy Committee will be free to start voting on higher interest rates before the next election. But taking the handcuffs off doesn’t necessarily imply the captive will actually move his hands. Rates won’t necessarily rise the moment forward guidance comes to an end.
Indeed, today the Governor signalled that markets, which currently expect the Bank to start lifting rates in early 2015 and to bring them up to 1.7% by the end of 2016, may be getting ahead of themselves. However, if not before the next election, rate rises are likely shortly afterwards.
With the end of forward guidance (eg the handcuff period) already on the horizon, some have construed this as evidence of the policy’s failure. After all, it only kicked in three months ago. What, they ask, was the point of it in the first place?
The Bank’s answer is that forward guidance has helped cement the economic recovery; that recovery has come along sooner than expected, so it’s right forward guidance will come to an end (well, in late 2014/early 2015). To use a rather odd analogy, consider the male honeybee. It dies as soon as it fertilises the Queen bee, but its death allows the rest of the colony to survive. In the same way, forward guidance, having stimulated economic recovery, will inevitably need to expire for the rest of the economy to recover. It is, in economic terms, the supreme sacrifice.
Economists are likely to argue about the wisdom or otherwise of the policy for some time. What matters for most of us is that growth is returning to the UK and that interest rates are likely to rise a touch sooner than expected.
One final noteworthy aspect of today’s Inflation Report press conference was the amount of time the Governor spent answering questions about the housing market. There is growing concern about a bubble (or at the very least some regional bubbles) emerging in UK property prices. Mr Carney is clearly sensitive to this – we shall have to wait until the next meeting of the Bank’s Financial Policy Committee to see whether he’s willing to take action on it.