Should UK’s Carney act to persuade markets?
It's another big week of information on the U.K. economy, as questions remain about the quality and sustainability of the rebound. From a position of no growth, current forecasts should be warmly received, but there's still a big doubt about whether a recovery that's been helped by housing and a consumer upturn can lead to strong investment-led growth.
Tuesday's better news on inflation may take some pressure of the squeeze in real wages, the Labour Party's new line of attack on the Government. Retail sales towards the end of the week should still be robust and manufacturing activity upbeat.
All of which means we're going through an interesting tussle between the skeptics who question the quality of growth, and those investors who want to test the Bank of England's resolve to keep rates on hold until 2016. Right now markets just do not believe it.
The unemployment rate has come down to 7.7 percent from 8.1 percent in a year, and continuing that sort of progress means we would hit the Monetary Policy Committee (MPC)'s 7 percent knockout much sooner in 2015. Plenty will depend on how quickly the labor force expands. We know the Bank's Governor Mark Carney thinks that to hit the 7 percent rate, the country needs to create 1 million private sector jobs, that figure based on there being 250,000 fewer people employed by the public sector. But even if Carney is proved right, he does have a question to answer now...what do you do when as a central banker you say something and the markets don't believe you.
Former European Central Bank board member Lorenzo Bini Smaghi is in no doubt. He told me earlier this month that in this situation there is only one course, and that's to act. This is why the most telling bit of information for the U.K. this week will be Wednesday's minutes from the Bank of England's last meeting.
In particular, what does the Committee make of the rise in rate expectations? We know MPC members say the bank rate is far more important to firms and households, and what's key is they understand these rates will stay low. But there is a chance that one or two members will decide that forward guidance is not working for financial markets, and they should follow Bini Smaghi's advice and act.
In turn, that means voting for more quantitative easing. At this stage, one or two members advocating more liquidity might not have a huge impact, though it would change the tenor of the discussion. Research firm Capital Economics suggests that if there's a material sign that a rise in gilt yields threatens to choke off the recovery, that's the point when things become different.