The Bank of England will publish its inflation report at 5:30 a.m. ET.
But all eyes will be on any comments Mark Carney may make regarding introducing forward guidance. to its monetary policy announcements. The idea is that knowing where the central bank stands on monetary policy and where it will be in the future will give businesses an incentive to borrow and help boost the economy.
Societe Generale’s Brian Hilliard writes that there are a few things to consider in terms of forward guidance.
Time-contingent or state-contingent?
Hilliard has previously pointed out that when an announcement on forward guidance does come, it is likely to be “state-contingent” — or dependent on economic data — even though he doesn’t think this is the best framework for the UK.
“The fact that the Chancellor’s request was framed in terms of assessing the merits of using intermediate thresholds being reached for some particular economic indicator points to the “state-contingent” approach being favoured by the MPC.”
The unemployment rate or nominal GDP growth are considered the top contenders for the choice of the threshold.
Hilliard doesn’t think the unemployment rate is viable for the UK because the participation rate has risen in the UK (compared to the U.S. where the participation rate has fallen driving down unemployment rates). Moreover there was a significant decline in productivity during the recession.
“If that cannot be explained one should be cautious in using this variable as the yardstick to use for forward guidance,” writes Hilliard. “Our fear is that with domestic inflation pressures so insensitive to downward pressure from the large output gap, aiming for a much lower unemployment rate would risk increasing those pressures.”
Nominal GDP however “figured strongly in the recent debate about the choice of target variable for the Bank of England remit. Moreover, the MPC, and in particular the Governor, cited the weakness of nominal GDP as a prime reason for embarking on QE.”
But Hilliard does think the state contingent forward guidance is more likely to use unemployment rate as the threshold variable.
The other question is will the guidance apply on the way up and down? The Fed has tied its forward guidance to developments in the unemployment rate and tied changes to this on the way up and down. The Fed would look at a few other labour market indicators too when adjusting policy tightening. In the UK however, Hilliard writes that the focus is just on when it would reverse easy monetary policy.
“But it is easily possible that Carney will wish to keep the door open for more easing in the form of rate cuts or more QE, in which case the MPC could frame the guidance in a way that specifies a threshold for that as well, just as the Fed has.”
“…Whatever variable is chosen as the threshold variable, there will always be a background constraint that inflation must remain well-behaved.”
And what should we expect from the inflation report itself?
UK consumer price inflation is currently at 2.9%, while the target is 2%. The Bank of England’s remit was amended to allow for “flexible inflation targeting,” earlier this year and pushing inflation back down to that 2% target isn’t as important anymore.
Hilliard writes that whether it comes tomorrow, or in November’s report, we should expect some bigger, permanent changes.
In the second half of the year Hilliard says we should expect 1. Alternative scenarios 2. More detail on the consensus forecast 3. Include discussion on how “outturns have differed from expectations.” 4. Increasing communication on outlook for policy.
In the light of better economic data, many wonder if forward guidance is even necessary anymore. Hilliard argues it is.
“The MPC does not publish an estimate of the output gap, nor do we expect it to start doing so but recent Inflation Reports make it abundantly clear that a large gap exists. In addition, since the publication of the last Report in May, the benchmark revisions to the national accounts have revised up the size of the hit to GDP from the recession. So there is more ground to make up, even after upward revisions to last year’s GDP data. Furthermore, the current recovery still stands out as being extremely anemic. The current recovery is the only one, after over five years from the peak of output, in which the economy is far from regaining that peak.”
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