Forward!

By Mike Peacock
August 7, 2013

The Bank of England will give the government its blueprint for “forward guidance” when it publishes its quarterly inflation report, a big moment in British policymaking.

Canadian Mark Carney, in his second month at the helm, was heralded in advance as the man to kick start a languishing economy but with green shoots sprouting all over the place that may not be needed. Nonetheless, if companies and households can be convinced interest rates will stay at record lows for a prolonged period, that could boost investment and spending and help solidify a recovery that now looks to be in train.

After the U.S. Federal Reserve indicated that it may soon start to phase out its bond purchases – two of its policymakers again pointed to September yesterday – the Bank of England made a first stab at forward guidance last month, saying a rise in UK market rates was misguided. Now it will be more precise.

There is a trade-off. The clearer the guidance is about how long rates will stay at record lows the more effective it will be in persuading people to spend. But if time lines are spelled out, the greater the threat to the central bank’s reputation given how quickly things can change.

Earlier this year no one was talking about robust UK growth. They are now. Safer, but less definitive, to go down the Fed’s route of setting an economic target for unemployment or GDP with an inflation caveat attached.

Even that is tricky since economists can’t agree how much permanent damage was done to the UK economy by the financial crisis – so nobody knows precisely at what level of growth or unemployment wage and other prices pressures will start to build. Some of Carney’s colleagues at the Bank have already voiced doubts about forward guidance.

Don’t forget the more routine inflation report either following a run of startlingly strong data suggesting the UK economy, which posted growth of 0.6 percent in the second quarter, could do even better in the third. The Bank of England raised its growth forecast for the first time in years in May’s report and may have to do so again.

Having said that, the economy still hasn’t got back to the level of output it achieved before the financial crisis so there is a clear need to demonstrate that no policy tightening is looming.

Markets are pricing in no rate rise before late 2015. As usual, the central bank will insist that inflation will be close to its two percent target over a two-year horizon even though that has rarely come to pass for several years.

Looking further ahead, the odds are that both Carney and Mario Draghi at the European Central Bank will look to forward guidance to keep a lid on market rates, thereby avoiding the need for more dramatic policy action.

More printing of pounds looks increasingly less likely. Britain is clearly picking up – albeit thanks to the old drivers of consumer spending and the housing market, so there’s not much economic rebalancing going on.

Even the euro zone looks set to start growing again in the third quarter with Italy and Spain joining the party, something that would have been unthinkable a few months ago. The Bank of France has just forecast growth of 0.1 percent in Q3.

German industrial production figures for June are due after a mammoth rise in industry orders – 3.8 percent on the month – was reported yesterday. Logically, a surge in orders should see output increase in the following months but nonetheless the figure will be closely watched by markets in case it outstrips the +0.3 percent forecast.

The Czech parliament will hold a confidence vote on the interim government of Prime Minister Jiri Rusnok which it could well lose with centre-right parties pledging to unite in opposition to it. Losing the vote would force Rusnok to resign, prolonging political instability that started with the resignation of the previous centre-right cabinet in June. The country is deep in recession and the standoff casts doubt over the 2014 budget.

Romania’s central bank will release its inflation report having cut rates to a new low 4.5 percent on Monday, helped by slowing inflation and a new IMF-led aid agreement. Hungary’s central bank will release the minutes of its last meeting, at which it cut for the umpteenth successive time to four percent, and said rates could fall as low as three percent.

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