THE BLOG

Carney's Forward Guidance Falling on Deaf Ears So Far

07/08/2013 17:10 BST | Updated 07/10/2013 10:12 BST

This morning saw Mark Carney lay out the details of the Bank's Quarterly Inflation Report and, within it, the details of the Bank's forward guidance plan. The overall summary is basically what the market expected; that interest rates here in the UK will be tied to the performance of the UK's jobs market. This is almost a duplicate of what the Federal Reserve in the United States has been doing.

Therefore, all things being equal, the Bank's base rates should remain at current levels - 0.5% - or slightly below, until unemployment comes back towards a level of 7.0%. The current level of unemployment in the UK is 7.8%. The market, the Bank itself, most independent forecasters and economists and the Office of Budgetary Responsibility believe that the improvement needed in the jobs market will occur at some point in the mid-part of 2016.

Although we doubt a rate cut from the Bank of England is forthcoming, they have kept the door open to further asset purchases - or quantitative easing as it is commonly known - given the emphasis that Carney has placed on the fact that market interest rates imply a faster withdrawal of stimulus than is likely.

Market interest rates in the aftermath of Carney's announcement are not listening, however. After an initial dip for sterling across the board and a rally for shares on the FTSE 100, the direction swiftly reversed as markets started to bet that instead, the Bank will raise rates sooner rather than later.

The reasons are four-fold.

Carney made sure to emphasise that there were certain caveats to this forward guidance; occurrences which may not see rates rise, but certainly see a pause to the Bank's plan of forward guidance. These caveats or 'knockouts' that would make them change direction are; if inflation looks to be above 2.5% on an 18- month to 2 year timeframe, if longer-term inflation expectations start to become unpredictable or if the financial stability of the UK economy is threatened.

The issue that I've raised the most in the past year or so is not inflation, but the difference between inflation and wage settlements. Especially with the decrease in the savings ratio of late, as people attempt to keep their lifestyle going by raiding savings pots, price increases and their relation to wages are key to the survival of the recovery. Without one, we cannot have the other.

The fourth caveat wasn't so much mentioned by Dr Carney but certainly has been by the media in recent days. The title of yesterday's Evening Standard was "Boom Britain" - a by-product of a recent run higher in economic data from the UK economy that the recovery may be slightly more dependable. Dependable does not mean guaranteed however, and as soon the data from the UK starts to slow its rate of gain through the rest of Q3, we could see a dramatic reversal in circumstances.

There is also the possibility that some, more dovish members of the Bank of England, would have been looking for a lower unemployment target of maybe 6.5% as opposed to 7% - that will become clear in the minutes next week.

Carney came into the job with almost universal fanfare and we joked on Twitter before his speech that anything short of a gospel choir, and a full on parade with doves released by fawning economists would be a disappointment. I reckon the disappointment will be with Carney and how the market has taken his first foray into UK monetary policy.