Forward guidance, as I’ve said briefly before, is a little like a male honeybee. It lives only for the briefest period of time and dies when it has achieved its life’s purpose: in the case of the honeybee, fertilising the Queen bee; in the case of forward guidance, reigniting the UK economy.
So there should be little need to mourn when the policy comes to an end.
Whether the same view is held in the Bank of England is another question. Six months ago (actually a little less than that) the new Governor, Mark Carney unveiled the policy, which committed the Bank to holding off even considering lifting borrowing costs until the unemployment rate had dropped to 7%.
At the time, the Bank was pretty confident this moment would not arrive for another two years. And with inflation stubbornly above the 2% target and the Bank duty-bound to try to get it back on target, there was plentiful speculation that it would lift borrowing costs rather sooner. In the event, both of these assumptions – about jobs and prices – have proved well off-beam.
The labour market has improved sooner than expected, with the jobless rate hitting 7.1% in the three months to November. Against many expectations, inflation has also fallen to 2%. There’s a decent chance the unemployment rate is already at 7% or below (the statistics are terribly laggy).*
This leaves the Bank Governor with two options – assuming, of course, that he has no intention of raising rates any time soon (most would agree that that’s the case). The first is to kill off forward guidance – to let it go the way of the honeybee. Sure, its life was shorter than he expected, but now it’s served its purpose, why not get back to targeting inflation which, conveniently, is no longer pointing towards higher interest rates?
The second is to plough on with forward guidance – to change the threshold from 7% to 6.5%, and commit to keeping discussion of an interest rate off the table until unemployment drops to that level.
The economists I’ve spoken to today are split quite evenly between option one and two. Those who support option one say shifting the goalposts so soon after the policy was introduced will discredit the Bank. Good riddance, some of them say. Those in favour of option two (keeping and fiddling with forward guidance) think the Bank is well within its rights to shift the threshold given the economy itself has shifted into another gear.
Up until today I rather suspected that the Bank would opt for the second option. After all, Carney is an intensely political creature (with a small p). It looks a touch embarrassing, personally, to ditch the policy you unveiled with so much fanfare in your opening months. I thought he would find whatever means he could to hang onto an adapted version of it.
But after today’s events I’m no longer so sure. First, because the minutes to the latest Bank of England meeting – also released today – include no hint that the threshold is about to be changed. Indeed, the key phrase is that even when the jobless rate hits 7% there is “no immediate need” for an increase in borrowing costs. This sounds not unlike the Federal Reserve’s statement in December, when it reduced the rate at which it is pumping cash into the US economy through quantitative easing, but added that it will not lift the benchmark interest rate until “well past the time that the unemployment rate declines below 6-1/2 percent” (confusingly, the Fed’s version of forward guidance involves a 6.5% unemployment threshold as opposed to Britain’s 7%). In other words, might the Monetary Policy Committee (and note any change would have to be agreed by a majority of the nine members) have gone cold on forward guidance?
Second, the Chancellor was asked about this dilemma today on the fringes of Davos. It was striking that in his response he mentioned the inflation target quite explicitly, but said nothing about forward guidance whatsoever.
Anyway, it won’t be long before we find out what the Bank’s plan is. Carney has a big speech in Scotland next week, in which he may give a few hints. Then there’s the next rate decision in the first week of February (there could be a statement). Then there’s the Inflation Report the week afterwards. Either way, monetary policy in Britain may be about to change yet again.
* Not that I want to throw a spanner in the works, it’s worth bearing in mind that the unemployment rate is a three month average. According to the ONS, the rate was 7.1% in September, 7.1% in October and 7.4% in November. So, strictly speaking it’s actually risen in the past couple of months. But these figures are highly volatile.