GO
Loading...

Should the Bank of England abandon forward guidance?

Wednesday, 8 Jan 2014 | 8:39 AM ET

With speculation growing that the Bank of England will have to change its forward guidance rules just months after they were brought in, some economists are starting to argue that the policy should be abandoned entirely.

Mark Carney
Jason Alden - Pool | Getty Images
Mark Carney

The policy, which involves explicitly signaling that interest rates set by the central bank will remain at their historic low of 0.5 percent until unemployment reaches 7 percent, was a central tenet of new Governor of the Bank of England Mark Carney's changes when he arrived at the bank last summer. Now, it may be revised to include an unemployment target of 6.5 percent, after unemployment fell more quickly than anticipated, according to a report in the Sunday Times.

(Read more: UK unemployment falls, putting rate hike in focus)

"That would make a mockery of a policy meant to provide clarity about interest rates. If the threshold can be lowered once, it can be lowered again, or raised for that matter," Rob Wood, chief U.K. economist at Berenberg, argued.

"When the threshold is reached, guidance should be allowed to die a quiet death."

UK economy cannot cope with higher rates: Pro
John Wraith, fixed income strategist at Bank of America Merrill Lynch Global Research, says an interest rate hike would hurt the U.K. consumer-led recovery.

The aim of forward guidance was to give fewer surprises to the market – and therefore make the U.K. less vulnerable to shocks – and Carney was always eager to point out that the 7 percent threshold was not an absolute line in the sand, but a "way-station." Another goal of the policy was to turn the BoE's focus from inflation, which hit a four year low of 2.1 percent in November, to unemployment. It has had a target of 2 percent inflation since 2003.

Carney's plans have been sent astray by a series of unexpectedly positive statistics on the U.K. economy, with measures such as unemployment and house prices performing better than forecast.

There is "growing confidence in the depth and breadth of the recovery," as Citi analysts have pointed out, with business confidence booming.

(Read more: Business optimism boosts hopes of solid UK growth)

The Bank's Monetary Policy Committee is expected to keep rates on hold when they meet on Thursday.

At the moment, the majority of economists expect rates to stay right where they are until at least the end of 2014, with most predicting that the Bank will raise them again in 2015.

- By CNBC's Catherine Boyle. Twitter: @cboylecnbc.

Featured

Contact Europe News

  • CNBC NEWSLETTERS

    Get the best of CNBC in your inbox

    › Learn More

Europe Video

  • Martin Schulz, senior economist at Fujitsu Research Institute, says the U.S. and Japan need to strengthen their economic relations and that the Trans-Pacific Partnership will be the main issue of this visit.

  • David Tinsley, U.K. economist at BNP Paribas, discusses the minutes of the Bank of England's rate-setting meeting and says that, with unemployment falling, these get-togethers could get "more interesting" and "fractured."

  • Fraser Howie, director at Newedge Singapore, says the PMI data reveals China is "in a bit of a rut" and that the government has a "horrible problem" as it can't bring out too much stimulus.