The recent rapid fall in UK unemployment is likely to result in the Bank of England changing the nature of its "forward guidance" at next week's inflation report, according to Credit Suisse analysts.
The guidance was first announced last August by new governor Mark Carney. The new policy effectively committed the BoE to continuing to holding rates at record lows until the unemployment rate fell below 7%. The Bank's expectation was that this would not happen until 2016 but with the rate now standing at around 7.1%, analysts are beginning to question how much longer the guidance can be maintained in its current form.
Today the BoE kept rates pegged and gave no indication of the future path for its forward guidance policy. However, analysts at Credit Suisse, led by Neville Hill, believe the guidance is "likely to expire a mere six months after the policy was announced".
Credit Suisse's main criticism of the policy is the high level of the unemployment threshold. In a note on UK economics and strategy, titled Join the Dots, the analysts argue that the 7% rate wasn't too far below that prevailing at the time of the August inflation report and was consequently vulnerable to a sudden change of circumstances. Furthermore, they argue, the 6.5% structural unemployment rate estimate on which it was based looked high.
Hill comments: "We think the high level of the threshold was due to the desire to get all members of the MPC to sign up to it. With unemployment approaching the threshold, there still seems to be significant slack, as evidenced
by still subdued wage growth and pay settlements. That's a judgement that seems to be reflected by several MPC members.
"Given high levels of debt, and a still young upswing, we think BoE Governor Carney will want to provide more forward guidance about the likely path of rates over the next few years. The challenge, of course, will be for the Monetary Policy Committee to do so in a way that is deemed credible. "
Yet Hill and his colleagues are keen to note that forward guidance and, specifically, the unemployment rate threshold was "a useful and credible" anchor for markets, firms and households to base their expectations
on how long the rates could remain at current levels.
The looming expiry of the threshold, however, threatens to create uncertainty. Hill and his colleagues are convinced this will have to be addressed by Carney: "Given the extraordinarily low levels of rates, strong recovery and uncertainty over the BoE's reaction function, a new anchor would be useful. Otherwise the risk is that in the vacuum, markets and agents make too aggressive an assumption about the path for rates and behaviour adjusts
Credit Suisse reckons the MPC's reticence in addressing forward guidance and the threshold indicates that a majority of the Committee's members do think rates need to remain on hold for some time - something markets increasingly disagree with.
Hill says: "We think the most likely outcome at next week's inflation report is that each MPC member will mark up a path for rates that they believe appropriate on the basis of their outlook for growth and inflation. The presentation would be similar to that used by the Fed in its communication. We expect it to signal that most MPC members think the appropriate pace of policy firming is slower than that expected by the market. "