Forward guidance on forward guidance

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As Neil said in his blog yesterday, Governor Carney was expected to announce a different approach to forward guidance in the Inflation Report today, particularly as unemployment had fallen far more quickly than expected, and the economy had continued to grow.

Today's Inflation Report did indeed show a stronger outlook for the economy – with growth of 3.4% expected this year – combined with inflation expected to remain around the target over the forecast period.

Unsurprisingly, then we do have a new approach to setting interest rates; the Bank has published “further guidance on the setting of monetary policy once the unemployment threshold has been reached”.

It's more complicated than the previous guidance, and a lot closer to the Bank's old approach of making month-by-month decisions. As Carney pointed out though, while last August saying rates would be on hold for some time was an “easy call” the economic improvements we've seen over the past few months mean the UK economy is in a “different place” and this means the approach to monetary policy has had to change.

Crucially, now – rather than a focus on the unemployment rate – the Monetary Policy Committee will be looking for improvements on a broad front, not just one variable, though Governor Carney said that “headline wish is to eliminate spare capacity over the forecast horizon”.

So what variables will the Bank of England be looking at?

One key move the Bank will make is to increase the transparency around its decision-making and forecasting process. They will be providing greater information about a number of the metrics they examine and forecast. Broadly, the Bank will look at:

The sustainability of the recoveryThe Bank will try to determine whether economic growth is broad-based and likely to be sustained. They will look at productivity, real incomes, business investment, availability & cost of credit

The extent to which supply responds to demandThe Bank will also look at the pace at which spare capacity is being used up by examining movements in labour and capital productivity in response to the economic situation

The evolution of cost and price pressuresFinally, the Bank will aim to keep a lid on inflationary pressure, so factors such as wage growth, import price pressures and inflation expectations will affect their judgement.

And what is the likely path for interest rates?

Governor Carney stated the UK economy faces a number of headwinds, as well as less pressure from imported inflation and argued that the medium term interest rates consistent with growth and inflation at the target rate were materially lower than in the past.

Market expectations are suggest we will not see the first rate rises until the first half of 2015, and when they do come Carney was keen to state that any increase in rates was likely to be gradual.

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