BOE may struggle to agree clear guidance

The Bank of England faces a tough trade-off this week between making a powerful commitment to keeping interest rates low for a long time, and taking a vaguer approach that leaves it less at risk of an embarrassing mistake.

Chancellor George Osborne has asked the new Bank chief Mark Carney to broker agreement among the bank’s policymakers on the use of “forward guidance”, something done by the US Federal Reserve, the Bank of Canada which Carney used to run and, more recently, the European Central Bank.

It essentially means telling markets, businesses and consumers what it plans to do. The bank has historically resisted tying its hands by committing itself to a future path for interest rates, and instead has tried to prop up the economy since 2009 with bond-buying as well as interest rates of just 0.5 per cent.

Whether to change this dominated the two-day policy meeting which ended on Thursday, and a formal announcement is due on August 7 alongside quarterly economic forecasts.

After the US Federal Reserve indicated that it may soon start to phase out its bond purchases, the bank made a first foray into forward guidance by saying on July 4 that a rise in bond yields in Britain was not consistent with its weak economy.

But the bank’s nine-member Monetary Policy Committee is likely to find it far harder to agree on more detailed guidance, Charles Good­hart, a former MPC member and a professor at the London School of Economics, said.

“It is going to constrain the way the MPC’s own proceedings work,” said Goodhart, now an adviser to Morgan Stanley.

Carney stressed the need for a pledge that could be easily explained to the public. Goodhart expects something similar at the Bank, with a pledge to keep rates unchanged until the middle of 2015.

But he concedes guidance of this type is a close-run thing. In Canada, central bank officials are expected to reach a consensus with their governor, while Britain’s MPC members are required to vote in line with their personal views and must explain themselves to lawmakers in Parliament.

In addition the MPC’s four external members serve terms of only three years, meaning some may not be in office at the end of a period of guidance and would in effect commit a successor.

Another challenge for the MPC is to agree on a level of unemployment at which it would consider raising interest rates.

Britain’s unemployment rate stands at 7.8 per cent, compared with just under six per cent before the crisis.

However, most economists expect wage inflation will start to build long before unemployment falls to its pre-crisis rate, as the crisis reduced the pool of workers with the right skills.

Economists point out that the European Commission estimates the jobless rate at which this happens could be as high as 7.5 per cent, while the International Monetary Fund thinks it might be sixper cent.

The lower the unemployment threshold set by the Bank, the more stimulatory its guidance will be, but the greater the chance it might be committing itself to allowing a sig­nificant amount of inflation above its two per cent target.