August 2, 2013 / 8:24 AM / 5 years ago

BOE FOCUS-Bank of England may struggle to agree clear guidance

* Bank considering guidance on future monetary policy

* Guidance may help stem rise in UK government bond yields

* Powerful steer risks committing bank to bad policy

* Consensus may be hard on nine-member policy committee

By David Milliken

LONDON, Aug 2 (Reuters) - The Bank of England faces a tough trade-off next 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.

Finance minister George Osborne has asked new Bank of England chief Mark Carney to broker agreement among the bank’s policymakers on the use of ‘forward guidance’, something done by the U.S. 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 of England 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 percent.

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

Carney - who took over the bank a month ago - has repeatedly spoken in favour of forward guidance, and the bank is keen at the moment to make clear it does not want borrowing costs to rise any time soon.

After the U.S. Federal Reserve indicated that it may soon start to phase out its bond purchases, the Bank of England 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.

The Bank of Canada in 2009, under Carney, said interest rates would stay on hold for 15 months, as long as the inflation outlook remained under control. Carney stressed the need for a pledge that could be easily explained to the public.

Goodhart expects something similar at the Bank of England, 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.


For these reasons, many economists polled by Reuters expect the Bank of England to agree on a kind of guidance similar to that pursued by the Fed. The Fed has pledged not to consider raising interest rates until the U.S. unemployment rate falls to 6.5 percent.

In other words, it tied the stance to a specific event.

This so-called state-contingent guidance has the advantage of allowing policymakers to present a common stance even if they individually disagree about how fast the economy will recover.

It also spares them regular questions about whether to extend the timetable for keeping rates on hold, and avoids the implication that policymakers expect growth to remain weak throughout the period.

But it has a flip side of offering a less clear public commitment on how long rates will stay low, and poses the challenge of what variable should be used.

Unemployment is a problematic for in Britain, as it rose far less than would normally have been expected given the scale of Britain’s downturn after the financial crisis.

But most economists think there are even bigger challenges to other options, such as using gross domestic product in either real or cash terms, or a measure of spare capacity. Britain’s GDP data is frequently revised, and other metrics would be complicated to explain to the public.

“Unemployment is the clear front-runner,” said Rob Wood, a former Bank of England economist now working for Berenberg Bank.


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 percent, compared with just under 6 percent 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 percent, while the International Monetary Fund thinks it might be 6 percent.

The lower the unemployment threshold set by the Bank of England, 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 2 percent target.

To appease more hawkish policymakers worried about the risk of inflation, the bank may borrow another idea from the Fed and add a get-out clause, saying that if inflation expectations rise above a certain level it will consider raising interest rates.

This level may be set at the 2 percent target rate, or slightly higher if the bank wants a more stimulatory policy. But either way it will further complicate the MPC’s message.

It will also make it harder for the MPC to reach consensus - potentially leading it to make a vague statement like the ECB’s commitment to keep rates low for “an extended period”.

For this reason, both Goodhart and another former MPC member, DeAnne Julius, urge caution in expecting too much.

“I think they will hedge their bets,” Julius said. “It wouldn’t be a big surprise if forward guidance turns out to be quite a damp squib and there isn’t any real guidance.”

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