WHAT IF BRITAIN INTRODUCES GUIDANCE?
- What if? Any announcement on guidance will come with the Inflation Report on 7 August. What are the options and what would they mean?
- Clear and simple: The point of guidance is to give a clear and simple message about the Bank of England’s intentions. Aggressive guidance would push back the expected timing of rate hikes which would mean the tightening, when it came, would have to be more aggressive.
- Anti-tightening: Less aggressive guidance would reinforce market expectations that rates will stay low until 2016, rather than pushing out rate hikes. That can still be a powerful message, by reducing the risk of misunderstanding the BoE’s reactions and by sending a clear message to the public that rates are likely to stay low.
- Time or state-contingent? The BoE could say interest rates will be kept low for a period of time, or until an economic threshold is met. Either would likely be combined with an inflation caveat, eg as long as inflation is forecast to be close to 2% in 2-3 years’ time.
- Time-contingent tells us less: With the inflation caveat, this would amount to saying interest rates will stay low for long enough to get inflation to target, which we already know. But by being clearer, the BoE could reinforce the message.
- Growth or gap? State-contingent guidance could be tied to a real or nominal growth threshold or a gap threshold, like unemployment. Growth thresholds are clear and, in principle, the BoE could control nominal GDP. A gap threshold would, however, allow the BoE to indicate how far away from normal it thinks the UK economy is.
- GDP can be heavily revised: This means growth thresholds can make the message more complicated. The BoE might want to tighten despite the threshold not being met because it expects GDP to be revised up. This is not a killer blow, because the BoE already publishes an assessment of where growth will be post-revisions.
- Possible unemployment thresholds: An unemployment threshold of 6.5% would be a very dovish signal. The Office for Budget Responsibility (OBR) for instance does not expect unemployment to have reached 6.5% by the end of its forecast period in Q1 2018. A 7% threshold would be close to the “anti-tightening” stance.
- Possible growth thresholds: The BoE’s latest forecasts imply it expects nominal GDP growth of 4-4.5% yoy over the next three years. Therefore a threshold of more than 4.5% nominal, or more than 2.5% real, would be dovish.
- Inflation caveat important too: The Fed can get out of guidance if inflation is forecast to be above 2.5% or if inflation expectations become deanchored. If the BoE adopted a 2.5% inflation caveat, this would be very dovish, so 2% may be more likely.
- A mild alternative to threshold guidance would be for the BoE to publish an interest-rate forecast to go alongside its inflation forecast.
- Further asset purchases not ruled out: It is hard for current policymakers to tie their successor’s hands, so guidance may not be convincing. Still, further asset purchases look unlikely at present so we revise our forecast to no more, down from an additional £25bn.
Chief UK Economist
+44 20 3207 7822
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