Mark Carney's much anticipated first speech as governor of the Bank of England (BOE) was delivered to a Nottingham ballroom, packed with business people from across the country. It was an opportunity for him to clarify the BOE's recent foray into the realm of 'forward guidance' and to try and reassure sceptics about his plan to keep interest rates low for the next three years.
I'm sure that, in the back of his mind, the Governor will have also wanted to emphasise to the market that the recent increase in yields and rate expectations are not in keeping with where the Bank believes they should be trading.
The anchoring of rate expectations in the UK remain centred on the unemployment rate. 7% unemployment is a level that needs to be met before the Bank's Monetary Policy Committee (MPC) will even consider raising rates here in the UK. Unemployment in the UK currently sits at 7.6% and with recent improvements it is not out of the realm of possibility that we see continual falls towards the 7% level as the year goes on. After all, Q2 GDP was recently reassessed to have grown by 0.7% while construction and manufacturing releases point to multi-year record highs.
The Bank is rightly worried that the tightening of market rates may stymie the business lending and mortgage borrowing it is so trying to engineer. The shift in rates expectations have been the market price in a quicker increase in the Bank of England's base rate than before Mark Carney took over. The first increase is pencilled in for September 2014 with a full 100bps increase by the end of 2015. This would of course only happen on the basis that the unemployment level is well below the 7% by then.
The disconnect occurs when you look at what the BOE is forecasting for the UK's jobs picture. The MPC puts the chances of unemployment being below 7% in three years' time at roughly 50% (i.e. there is pretty much the same probability that unemployment is above 7% in 2016 as it is below). That may reek of 'finger in the wind, your guess is as good as mine' forecasting, but shows that the path of improvement in the UK is by no means linear with an improvement in GDP.
The difference is one of productivity, and the emphasis that the Governor put on productivity and wages within this speech naturally leads one to think that he believes the output gap - the difference between what level the UK economy is producing at and where it could be - is a lot bigger than maybe originally thought. This dovetails nicely with this reassertion that the 7% level of unemployment is not a trigger for rate hikes but more of a threshold: one box being ticked does not necessitate another check mark.
To gage the general reaction to Carney's words, there is no better barometer than the reaction of the markets. Unfortunately for our new Governor, they once again seem to be holding their line that they are right and will need more convincing that rates will stay lower for longer. Sterling has moved higher, as has the yield on UK treasury debt while the FTSE barely took notice.
Carney warned that further measures may be deployed should growth be hurt by these high rates - it may take that kind of action to persuade the markets to listen.Suggest a correction