Carney’s 'forward guidance' initiative fails to win full committee support

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Mark Carney's smooth start as Governor of the Bank of England has run into a bit of a bump.

It emerged on Wednesday that Mr. Carney's first major policy initiative – linking future interest rate hikes with unemployment – has not received unanimous support within the monetary policy committee, a nine-member group that sets the monthly bank rate. There were signs of further potential divisions within the MPC on Wednesday that could lead it to act on interest rates sooner than Mr. Carney would like.

Many economists have questioned Mr. Carney's "forward guidance" policy, saying it's confusing and may not be effective because the British economy is improving more quickly than the bank has forecast.

Last week, Mr. Carney unveiled a dramatic shift in bank policy, announcing that interest rate hikes would be tied to unemployment. The bank would keep its key lending rate at 0.5 per cent until unemployment fell to 7 per cent from the current 7.8-per-cent level, which it estimated could take three years.

There were some conditions to the policy, such as the outlook for inflation not going above 2.5 per cent within 18 to 24 months. If that happened, the bank could act sooner, Mr. Carney said.

What was not known was how much support he had for the policy within the MPC. The committee's view became clear Wednesday when it released minutes of its last meeting, which included a vote on the new policy.

One member, economist Martin Weale, voted against it. According to the minutes, he supported the idea in principle but disagreed on implementation.

He believed the time frame to monitor a sudden rise in inflation should be shorter than 18 to 24 months.

He "saw a particularly compelling need to do more to manage the risk that forward guidance could lead to an increase in medium-term inflation expectations, by setting an even shorter time horizon," according to the minutes.

There were also signs of other splits in the MPC. The minutes showed that some members wanted to inject more money into the economy, through a program called quantitative easing. The bank has already pumped in £375-billion ($600-billion) through QE, and two committee members, Paul Fisher and David Miles, have frequently voted to increase it further. It appears Mr. Carney persuaded them to change their minds in July and they voted with the others not to raise QE.

But it seems they may be ready to return to their original positions: The minutes said some unidentified members saw a compelling reason for more monetary stimulus; however, they decided "there was merit in first supporting the implementation of forward guidance and waiting to gauge its impact, in particular on financial market prices, before reconsidering an increase in the committee's programme of asset purchases." That could set up future divisions in the MPC.

All of which raises questions about the effectiveness of Mr. Carney's policy. Many economists believe that the bank is too cautious and that unemployment could fall to 7 per cent much faster, leaving the bank's forward guidance ineffective.

Some say the bank could reach its threshold as early as next year.

That view was supported by job figures released Wednesday by the Office for National Statistics (ONS). While the unemployment rate remained at 7.8 per cent for the second quarter, there were signs of substantial improvement in the labour market.

For example, the jobless rate for June fell to 7.4 per cent and unemployment claims dropped by 29,200 to 1.44 million in July, the ninth consecutive month the figure has fallen. Total jobless claims are at the lowest level since early 2009, according to the ONS.

The July jobless figure could come in at 7.4 per cent as well, bringing "the three-month average down … to 7.6 per cent and … cast doubt on the Bank of England's ability to anchor interest rate expectations at current levels," said Michael Hewson of CMC Markets in London.

"Central bank jawboning works only if investors believe the central bank means what it says, and today's minutes will not increase confidence in Carney's words from last week," Rob Wood, a former bank economist who is now at Berenberg Bank in London, told Reuters.