As was largely expected after last month's foray into forward guidance, the Bank of England's new Governor has this morning provided some explicit guidance into the future conduct of monetary policy:
“The MPC intends at a minimum to maintain the present highly stimulative stance of monetary policy until economic slack has been substantially reduced, provided this does not entail material risks to price stability or financial stability”
The Inflation Report notes that a recovery does appear to be taking hold, and the MPC revised up their forecasts in this quarter's report. They now expect growth of 1.5% in 2013. This is up from their previous forecast of 1.2% and some way above the median forecast of 1.1%.
Nonetheless, the MPC feel that the pace of growth is below that needed to make material inroads into the margin of slack there still is in the economy (see Lee's blog from yesterday). As a result, their view is that there is still a role for stimulative monetary policy to play in supporting the recovery.
Below are some key facts about forward guidance:
Why are they doing this?
In his opening remarks, Carney put forward three key reasons:
- to reduce uncertainty about the future path of monetary policy, and help to avoid the risk that market interest rates rise prematurely as the recovery gains traction
- to provide greater clarity regarding the MPC's view of the appropriate trade-off between inflation, growth and employment; and
- to give monetary policy greater scope to explore the potential sustainable level of employment and output without putting price and financial stability at risk.
When might monetary policy move?
Following the US example, the MPC have set a target rate for unemployment. In this case the threshold is 7% (ILO measure). Above this rate, the MPC will neither raise the Bank Rate from its current level of 0.5% nor reduce the stock of asset purchases. In fact the committee will “stand ready” to engage in further asset purchases should this be warranted.
So what about inflation?
Inflation does remains above target, but the issuance of forward guidance is a recognition of the trade-off between returning inflation to its target and ensuring the nascent recovery continues.
But this can only go so far. If inflation shot up then the Bank could risk its credibility by continuing with stimulus. There are, therefore, some safeguards in place:
- In the MPC's view CPI inflation will be no more than 0.5 percentage points above or below the target in 18-24 months' time
- Medium-term inflation expectations must remain “sufficiently well anchored”
- The FPC must judge that monetary policy does not pose a significant threat to financial stability
Will there still be monthly decisions?
Yes, the Bank Rate (and level of asset purchases) will be set monthly, but these additional criteria will now be explicitly taken into account.
When might interest rates rise?
The implication of the report is that both interest rates and QE will remain unchanged until mid-2016. However, this is just guidance; if the economic situation changes so might monetary policy.