Bank Of England Follows Bernanke And Adopts Explicit Rate Guidance
Early Wednesday, the Bank of England, led by Governor Mark Carney, formally adopted forward rate guidance. The BoE became just the second major central bank to adopt such policies, following Ben Bernanke of the Federal Reserve in tying rate hikes and other policy initiatives explicitly to economic data.
"Explicit Rate Guidance"
Governor Carney sent the British pound on a whipsaw as he adopted what he termed "explicit rate guidance." The Bank of England has now tied any future rate hikes to the unemployment rate, noting that rates will not rise until at least the unemployment rate reaches 7.0 percent from the current 7.8 percent; the Bank of England does not see this until 2016 in its current forecasts.
"The [Monetary Policy Committee] intends not to raise Bank Rate above its current level of 0.5% at least until the Labour Force Survey headline measure of unemployment has fallen to a threshold of 7%" said Carney in his opening remarks. "While the unemployment rate remains above 7%, the MPC stands ready to undertake further asset purchases if further stimulus is warranted."
Carney also noted that the MPC, the policy making committee of the BoE akin to the FOMC, would not look to sell any of its bond holdings until at least this threshold is reached. "But until the unemployment threshold is reached the MPC intends not to reduce the stock of asset purchases from the current £375 billion."
Carney did note that the BoE would not stick to these thresholds indefinitely if risks to either the bank's inflation forecast or financial stability were to arise. "The Bank of England's unwavering commitment to price stability and financial stability is such that this threshold guidance will cease to apply if material risks to either are judged to have arisen," said Carney. "In that event, the unemployment threshold would be ‘knocked out'."
The Bank of England has not increased the size of its asset purchase program since July of last year, when the BoE boosted its purchase program by an additional 50 billion pounds to 375 billion pounds. However, the BoE did launch the FLS program since then aimed at lowering market interest rates for borrowers.
The guidance issued by Carney appears to be an anti-taper, as it opens the door to additional purchases in the future. Also, Carney noted that short term market rates appear to be pricing in rate hikes sooner than the third quarter of 2016, when the BoE forecasts the unemployment rate will drop to its 7.0 percent threshold, and thus sees downside for yields in the U.K. bond market.
Real Improvements Across the Nation
Carney noted that the forward guidance thresholds were chosen as the BoE fears taking its foot off of the proverbial pedal too soon. "There is understandable relief that the UK economy has begun growing again," he said. "But there should be little satisfaction. Much is at stake as we seek to secure this recovery and return inflation to the target."
"A fall in unemployment from 7.8% now to the 7% threshold would, given the normal growth of the labour force, mean well over three quarters of a million new jobs over the three-year forecast period. A recovery in productivity driven by a recovery in demand would mean faster growth of real incomes. Such outcomes would represent real improvements in the lives of people across the nation."
Cable Gains Nearly 300 Pips
After dropping initially on the headlines that the BoE will keep easy-money policy for longer to a session low of 1.5204, the pound rallied nearly 300 pips against the dollar to a high of 1.54918 before consolidating gains around 1.5475. Meanwhile, British stocks sold off as the FTSE 100 Index dropped 0.88 percent.
ForexLive's Ryan Littlestone tried to makes sense of the quick and strong reversal in the pound this morning, noting that hopes may have been too high for the forward guidance. "So forward guidance isn't a definitively set path for monetary policy but just an adjustment of previous targets," he wrote. "Yes it's narrowed them down somewhat and painted crosshairs on things like unemployment but it's still all 'wait and see' stuff and that's what the market doesn't like."
"Without sounding like I'm beating my own drum, it went pretty much as I expected. Rates stay low, the QE gun is still loaded but it's locked in the draw for now. The recovery is fragile and still faces risks but the emphasis is now on taking up the slack and improving productivity."
"Inflation has become an even bigger part of the equation today and they will need to monitor any home grown inflationary risk as that could affect the threshold that forward guidance is built on."
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