Markets give thumbs down as Carney changes strategy

Governor Mark Carney unveiled the banks strategy in London today. Picture: AFP/Getty Images

NEW Bank of England governor Mark Carney disappointed the market today as his long-awaited guidance on policy proved more cautious than had been hoped.

Although Carney departed from tradition by linking interest rate rises to a rate of unemployment below 7 per cent, the small print of his new policy left room for doubts – “knockout” clauses mean the bank can go back on its commitment if inflation threatens to spiral or financial stability is compromised.

Colin Edwards, economist at the Centre for Economics and Business Research, said: “Essentially, what we have is a compromise between a total commitment to a path of interest rates and a desire to retain some flexibility should economic circumstances change.

“While this may not be the solid commitment which markets may have hoped for, it does serve to reduce uncertainty by providing further clarification as to the bank’s thought processes when setting policy.”

Analysts also pointed out that recent evidence of a fast-moving recovery in the UK economy means the jobless rate could fall below the targeted level far more quickly than the three-year wait forecast by the bank.

The bank’s central forecasts do not envisage the official unemployment rate falling below 7 per cent until the second half of 2016.

But the bank today revised upwards its forecasts for economic growth for this year and the next two. It now expects GDP growth to come in around 1.4 per cent in 2013, rising to 2.4 per cent in both 2014 and 2015.

Carney stressed that even when unemployment falls to 7 per cent, that will not necessarily trigger an immediate rate rise. He also plans to keep the level of recently-created money invested though the bank’s quantitative easing programmes at £375 billion, and said the monetary policy committee (MPC) was prepared to print more money should the recovery stall again.

The FTSE 100 index rose immediately following Carney’s statement, but fell back as investors digested the full report, while the pound moved in the opposite direction as fears that the bank would turn a blind eye to inflation eased. The FTSE 100 fell 93 points or 1.4 per cent to close at 6,511.21.

The MPC will consider raising interest rates from their historical low of 0.5 per cent earlier if policymakers believe the consumer prices index is likely to exceed 2.5 per cent, looking ahead 18 month to two years.

But Sebastian Burnside, senior economist at Royal Bank of Scotland, said the committee had left itself considerable room to ignore any short-term spikes. He added: “This test is based on the bank’s own prediction of what inflation will be, which makes it quite hard to fail.”

However, he cautiously agreed with the bank that the UK economy still has significant spare capacity that will allow it to grow without putting too much upward pressure on wages and prices.

And Burnside expects that once the bank’s 7 per cent unemployment target comes on to the horizon, Carney will issue further guidance on how fast he thinks rates should rise.

“There’s a lot of focus on what date we expect the first rate hike, and that’s very important, but there’s an astonishing lack of discussion about what will happen following the initial move,” he said. “There’s as much, if not more, uncertainty in the economy about how fast rates will rise.”

The City awaits the minutes of the MPC’s August meeting, due out next week. They are expected to show that Carney achieved abroad agreement for his guidance policy, but anything other than unanimous backing would throw its credibility further into doubt.