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UK's Rapid Recovery Causes Carney to Change Tack

13/02/2014 09:45 GMT | Updated 14/04/2014 10:59 BST

The latest Quarterly Inflation Report from the Bank of England has seen Governor Mark Carney and the remainder of Monetary Policy Committee continue to emphasise that interest rates in the UK will remain low 'for some time'.

The Bank of England's base rate is 0.5%, and has been since March 2009, but recent signs of a recovery within the UK economy has increased pressure on the Threadneedle St institution to raise rates sooner rather than later.

To combat this, the Bank of England unveiled its 'Forward Guidance' plan in August of last year - a plan that would allow businesses and individuals to rely on lower, accommodative interest rates until the unemployment rate hit a certain threshold, in our case 7%.

The BOE maintained that this would allow rates to stay low until 2016, such was the malaise in the jobs market and the spare capacity in the UK economy.

Unfortunately for the Bank of England, the recovery has been almost too good for their liking.

The unemployment rate now sits at 7.1% and will likely break that 7.0% threshold next week. And yet, there are very few people out there who would want a rate hike this month - savers excepted.

So, With the Bank of England unable to meaningfully target unemployment for interest rate increases, it seems that Carney's 'Forward Guidance' strategy is now better described as a plan for 'Forward Suggestion'.

The plan does remain, in so much that rates will be kept low after the unemployment threshold has been hit - much like the Federal Reserve's forward guidance has changed in the past few months as it has become clear that job increases have come on quicker than had been expected.

The argument for not putting a de facto target in place is obvious. They have met this threshold in double-quick time, but that is not to say that another goal would also be hit within the MPC's timeframe.

Unfortunately the lack of a clearly defined target within the Bank's revised plans now leads to a different question; 'how is everyone, from economists to home-owners, savers to businesses, expected to interpret this?'

Better communication from the Bank of England will be the key to how this next phase pans out. Carney is relying on the 'soft sell'.

This report also included some 'bullish' news; the Bank of England is forecasting that the UK economy will grow at 3.4% in 2014. This figure is 0.6% higher than had been forecast in November and is double the forecast for German growth during the same period.

2015's growth estimate has also been revised higher - from 2.3% to 2.7%. As a reminder, growth in the UK throughout 2013 has been initially estimated at 1.9%.

Interestingly, the Bank now finds itself returning to focus on the traditional indicator of inflation to justify its interest rate decisions. The Bank of England is an inflation targeting body after all, despite all the bells and whistles of 'forward guidance'.

The recent strength of the pound will have helped. Sterling is 10% higher on a trade weighted basis since last March, and while this will keep pressure on UK export focused companies, sterling strength should allow inflation to be kept low.

So, the overall picture is one of a recovery, but a recovery that in the words of the Bank of England Governor 'isn't balanced or sustainable' - growth is very contingent on consumption and housing spending this year.

While that remains to be the case, rates will not be going anywhere anytime soon.

Jeremy Cook is chief economist at the foreign exchange company, World First