Forward guidance: it's complicated - Economics weekly

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Forward guidance: it's complicated - Economics weekly

Floods and severe weather grabbed the headlines this week in the UK but away from the front pages the Bank of England delivered some important, if somewhat complicated, messages on monetary policy.

Economic Analysis

17 February 2014

The Bank of England and Royal Exchange

The upshot is that rates aren’t about to go up any time soon, when they do rise they’ll go up gradually, and they’ll probably settle at a level that’s much lower than before.

Forward guidance 2.0: it’s complicated

Last August the Bank of England set out its first policy of forward guidance. It said that interest rates wouldn’t rise until unemployment had fallen to at least 7%, as long as inflation and financial stability weren’t causing concerns. Since then unemployment has plummeted to 7.1% and is expected to fall below the Bank’s threshold in the coming months. So are rate rises imminent? In a word, no. The Bank has replaced this rule with a new “phase” of forward guidance.

The new normal

In some respects the new phase of forward guidance will be a lot like how monetary policy used to work, with an assessment of how much slack there is in the economy at the heart of the decision-making process. But there are two major differences this time. First, the Bank of England is making its decisions more transparent, sharing its thinking on the key issues in much more detail. Second, the Monetary Policy Committee (MPC) is happy to talk about the future of interest rates explicitly, talking about rate rises being gradual for example.

What happens next?

Having set out the new framework, the Bank made three key points. First, interest rates aren’t about to go up because it thinks there is a lot of spare capacity in the economy. Second, when rates do rise, they will probably only go up gradually as the MPC wants to eliminate this slack over the next two to three years. Third, interest rates are unlikely to get to the 5% level set on average by the MPC before the crisis, even when the economy is back to normal.

What should businesses and consumers make of all this?

The short-lived first phase of forward guidance shows just how difficult it can be to predict the economic future. And for all the guidance of what the Bank of England plans to do over the next three years, Governor Carney made no promises. But it appears that the Bank thinks market expectations about the outlook for Bank Rate are in the right ballpark. So what would that mean? That would mean Bank Rate starting to rise in mid-2015, to around 2% by the end of 2016.

A good week for US economic policy… 

It was also an important week for monetary policy in the US. In her first testimony to the House Finance Committee, new Fed Chairman Janet Yellen reiterated her view that the unemployment rate is only a partial guide of job market conditions. Many Americans have stopped looking for work; others would like to work more hours. That’s why she said interest rates would remain low long after unemployment has fallen below the Fed’s 6.5% threshold for thinking about rises. Turning to fiscal policy, the House lifted the debt ceiling for at least another year, removing for a while the uncertainty that could have damaged growth prospects.

…but a bad week for US data

Retail sales fell 0.4% between December and January, the biggest drop since June 2012. Factory output fared worse, falling by 0.8%m/m, the worst outturn since May 2009. However, for now it appears to be a temporary, weather-induced soft patch in the data rather than something more serious.

Wachstum, croissance, crescita, crecimiento

“Growth” was the key word in the Eurozone last week. It picked up from 0.1% q/q in Q3 2013 to 0.3% in Q4. Germany maintained its status as the engine of growth with an export-led expansion of 0.4%q/q. But the good news was spread across most of the region. France, the second-biggest economy of the euro area, returned to growth with GDP up by 0.3%q/q; so did Italy, for the first time since 2011 (+0.1%q/q). The Spanish and Portuguese economies also continued to heal (+0.3%q/q and +0.5%, respectively). The recovery of the Eurozone remains slow and far from guaranteed but, in Q4 at least, was more broadly based than it has been in a while.

Construction rounds off a good year for the UK economy

Output rose by 0.2% in the final three months of 2013. Not thrilling but better than the original estimate (-0.3%). Growth of 1.3% for the sector as a whole in 2013 rounded off a solid contribution to UK growth. The biggest contributor to this rise was a rejuvenated housing market with new builds increasing by 10%. But total output is still 12% below its 2007 peak.


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