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economist-insights-2013 08 123.pdf

economist-insights-2013 08 123.pdf

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economist-insights-2013 08 123.pdf
economist-insights-2013 08 123.pdf

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03/04/2014

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Economist Insights
The Commitments
12 August 2013Asset managementWith the publication of its latest inflation report last Thursday,the Bank of England (BoE) joined the club of central bankscommitting not to tighten their policy stance (i.e. interest rates)and asset purchasing programmes for an extended periodof time.The new forward guidance from the BoE closely resemblesthe approach of the Fed: its monetary policy stance willremain unchanged (or eased) until the UK unemploymentrate has fallen to a threshold of 7% (the US unemploymentthreshold is 6.5%). The BoE’s commitment is subject to three’knockout’ conditions: the MPC inflation forecast 18 to 24months ahead remaining below 2.5%; medium-term inflationexpectations staying well-anchored; and that there is nothreat to financial stability.Within its new guidance framework, the BoE has also publishedfor the first time its forecasts for the unemployment rate. Itexpects unemployment to progressively fall and to stabilise at7.1 % in 2016 (see chart 1), and thinks it is more likely than notthat the rate will reach 7% in mid-2016. In other words, it doesnot expect to tighten its monetary policy stance until then.The new monetary policy framework has some impliciteasing bias within it. Due to labour market rigidities, theunemployment rate usually lags growth by about onequarter. This means that the BoE will keep rates low forlonger than the underlying pace of growth would suggest.In addition, the choice of an inflation knockout 0.5% abovethe official inflation target might imply that the BoE iswilling to tolerate higher inflation for longer. Finally, andin contrast to the US, inflation in the UK is already abovetarget and is likely to remain so for some time. This impliesthat real rates in the UK will remain at a lower level for aprotracted period.The BoE kept things as flexible as possible when setting itsthreshold and knockouts. The recent experience of the Fed hasshown that unemployment-based guidance can be a double-edged sword. Unemployment can come down for the ‘right’reason if growth accelerates but also for the ‘wrong’ one ifpeople decide to leave the labour force. And as the UK hasexperienced, inflationary pressures can be more resilient thanpreviously expected. For these reasons, neither the thresholdnor the knockouts are binding or automatic triggers. If one ofthem is reached then the BoE will reassess its monetary stance.
Joshua McCallum
Senior Fixed Income EconomistUBS Global Asset Management joshua.mccallum@ubs.com
Gianluca Moretti
Fixed Income EconomistUBS Global Asset Managementgianluca.moretti@ubs.com
Source: ONS, Bank of England, UBS Global AM
Chart 1: Slow beat
UK unemployment rate, BoE modal forecast and Okun’s law forecastbased on BoE GDP forecast
Last week the Bank of England published forwardguidance linking its monetary policy stance to the UKunemployment rate. The approach is similar to that ofthe US Fed, with a threshold unemployment rate andsome further conditions to be met before the BoE willtighten its policy stance. The BoE thinks it is likely thatunemployment will reach the 7% threshold aroundmid-2016. The challenge for Governor Carney will bekeeping his whole Monetary Policy Committee uniteduntil then.
6.06.57.07.58.08.5Okun's lawBoE forecastHistoryJun-16Jun-15Jun-14Jun-13Jun-12Jun-11Jun-10

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