One of the signal achievements that burnished Mark Carney's halo during his tenure at the the Bank of Canada was the introduction of forward guidance – a conditional pledge, issued at the height of the global recession, to keep interest rates steady for some time, under certain economic conditions.
So it was no surprise that Mr. Carney would take this no-cost confidence-booster to Britain when he took the helm of the Bank of England last summer. Scarcely a month into his new job, Mr. Carney took a page out of the U.S. Federal Reserve's playbook and tied future monetary policy directly to the jobless rate – in what we'll call his 7 per cent solution. As long as inflation remained tame, interest rates would not budge from an historic low of 0.5 per cent until unemployment fell to 7 per cent. That happy event, the central bank had concluded, might not happen before mid-2016.
But a stunning economic rebound in 2013 has ripped up the bank's timetable. Mr. Carney's 7-per-cent threshold may already have been reached and could well be breached by the end of the second quarter. That's a dramatic decline from a high-water mark of 8.4 per cent in early 2012.
Mr. Carney was already facing a barrage of criticism over his guidance policy and certain public comments, as the lustre of his image as a superstar central banker quickly faded. Now, pressure is mounting on the Bank of England Governor to lower the threshold or hike rates. Still, as expected, the central bank chose to leave rates unchanged this week at its first policy meeting of 2014.
"It is time for Carney to consider raising interest rates," says a Financial Times headline over a commentary by economics editor Chris Giles. The worst course, he writes, "would be to show guidance was entirely a sham by redefining the unemployment threshold, reducing it to 6.5 per cent."
Several analysts agree. "We believe the BoE will hike in response … rather than fudge the evidence and shift the threshold, essentially ditching the inflation target in the process," Philip Rush, Nomura's U.K. economist, said in a note. Nomura has tossed out its former target of early 2015 for an end to ultra-low rates and now forecasts the policy tightening will begin this August.
The more likely response, though, is that the bank will keep both its target and interest rates unchanged for the entire year. As Mr. Carney has tried to make clear, the 7-per-cent jobless threshold is not a trigger for higher rates but the level at which policy makers will consider a change in direction. And he has pointed out that there is still too much slack in the economy, growth remains unbalanced and business investment is less than robust. Another deterrent to tighter policy is the stronger British pound, which could pinch exports and discourage spending to expand production.
When he was still at the Bank of Canada, Mr. Carney reminded a Bay Street audience that "[a]ctual policy will always respond to the economic and financial outlook as it evolves."
Still, his assumptions about the British recovery have turned out to be spectacularly wrong. And he's not about to get back his halo any time soon.