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Inflation reprieve leaves forward guidance battered but intact

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Inflation reprieve leaves forward guidance battered but intact

Inflation remains benign enough that the Bank of England will not be forced to change forward guidance policy at its policy meeting on Thursday, despite a steady drop in unemployment.

Following the arrival of new governor Mark Carney (pictured) last summer, the BoE announced it was introducing a form of forward guidance, giving businesses and individuals advance warning about when its financial policies will change.

The Bank reassured markets it would not consider raising the bank rate from the historically low level of 0.5% until unemployment falls to 7%, then forecast within the third quarter of 2016.

But since then the UK economy has strenthened considerably, and by the third quarter of 2013 unemployment had fallen to 7.4 per cent, the lowest level since 2009, leading to concerns that interest rates could rise as soon as this year.

In a bid to quell these fears, some argue the MPC should announce a tougher threshold for the interest rate rise, by lowering the required unemployment level. 

But Simon Ward, chief economist at Henderson, told Wealth Manager that any tweaks made to forward guidance at the Monetary Policy Committee on Thursday 'would look a bit reactive,' as the policy is so new.

'I'm a bit sceptical that they will want to move the threshold so soon after introducing it,' he says. 'Carney always saw it as a threshold. They could say that although unemployment has fallen below 7%, there is no sign of wage pressure, so we are happy to keep rates for the forseable future.'

'If I was the MPC, I would try to shift attention to the inflation picture rather than lowering the threshold.'

CPI fell to a four-year low of 2.1% in November, bringing it close to the Bank's 2% target and lessening the need to raise interest rates.

While Azad Zangana, chief European economist at Schroders, is anticipating a change to the policy, he thinks the committee will wait until the inflation report meeting in February.

'I think it was a mistake to set the threshold at 7% when there was little analysis to show that this was the point at which unemployment will start to have an effect on wages,' he said, adding that even when joblessness does fall to this level, 'there is very little risk of exploding inflation'.

The economist thinks that while the BoE's credibility 'will take a bit of a hit' if forward guidance is altered, the MPC would prefer that to intense speculation over interest rate rises, with some experts predicting a rise as early as the end of this year.

Neil Williams, chief economist at Hermes, suggests there is scope for the committee to make an announcement on Thursday, but agrees the inflation report might be more a more compelling backdrop, as the bank could justify the change with an upbeat economic forecast.

'The MPC in 2014 may simply push back the staging post, to 6.5%, then 6% before hiking rates, simply because ‘Philips Curves’ (which demonstrate the link between job creation and wage inflation) are so flat,' he says. 

'Hypothetically, we may see some adjustment to this guidance as a ‘curtain raiser’ at the year’s first MPC meeting on Thursday, but why rush when it could be justified by a new economic forecast in the Bank’s next Quarterly Inflation Report in February?'

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