Economists said they believed British interest rates may be cut earlier than the projections announced Wednesday, by the Bank of England (BOE) as part of its Forward Guidance Policy.
The BOE governor Mark Carney announced the details of the Forward Guidance policy at a press conference at the BOE headquarters, with the intention of increasing the stimulus on the economy by providing certainty to businesses, lenders, homeowners and individuals.
Carney, who had implemented Forward Guidance as governor of the Bank of Canada, has just taken up the post as governor at the BOE.
The BOE announced it planned to keep interest rates at an historic low of 0.5 percent, where they have been since 1Q 2009, until unemployment falls below 7 percent.
There is no fixed date for this, but unemployment is currently at 7.8 percent, substantially higher than the pre-recession levels of under 6 percent, but substantially lower than many eurozone countries. Carney said that the BOE did not expect unemployment to hit the 7 percent mark until 3Q 2016.
The door was left open for extensions to the Quantitative Easing (QE) program, although the BOE was explicit that it did not regard that as necessary at the moment.
James Knightley, senior British economist at ING, said, "Market reaction (to the announcement) does seem somewhat cautious given the strong run of data and the fact that inflation is already at 2.9 percent and is likely to trend lower only fairly slowly."
Knightley added, "In our view there is still significant uncertainty on the outlook for growth, but we are becoming increasingly optimistic on the prospects. Consequently, we still believe that interest rate rises are more likely to start in early 2015 than 2H 2016."
He added that tying the policy to the unemployment rate -- which Carney said was chosen because it was unambiguous, easy to understand, well-known, and available monthly -- left it open to quick changes.
Knightley said the policy was also at the mercy of a stronger growth environment creating more jobs, and encouraging more people who had withdrawn from the workforce to re-enter it.
He added, "As the participation rate rises then this will make declines in the unemployment rate slower to materialize. This could risk stoking bubbles by keeping accommodative monetary policy in place for longer than is really required, hence the reason for the BOE to include the three 'knockouts'."
KNOCKOUT CLAUSES
These 'knockouts' are get-out clauses allowing the BOE a clear path to change policy.
The first 'knockout' is if inflation was forecast to be above 2.5 percent 18-24 months down the line.
The second is if medium term inflation expectations were no longer 'sufficiently well anchored; and the third is if the BOE's Financial Policy Committee thinks there is a 'significant threat to financial stability' then guidance could be ignored.
George Buckley, chief British economist with Deutsche Bank, analyzed the three 'knockout' clauses, any of which could see policy changes.
On the first 'knockout' (inflation forecast to be above 2.5 percent 18-24 months later), Buckley commented that this was "hardly an effective knockout given that since the BOE began targeting CPI inflation in 2004 there has not been a single Inflation Report which has forecast inflation at 2.5 percent or above two years hence."
Buckley said that the second and third knockout clauses -- if medium term inflation expectations were no longer 'sufficiently well anchored', and if the Financial Policy Committee thinks there is a 'significant threat to financial stability' -- were both "judgment calls".
He added, "These three 'knockouts' are of dubious importance and, based on past form, may never be binding."
"We believe the Bank may feel very different about the need to tighten policy in the future, and that potential threats to financial stability -- via a recovering housing market and increased borrowing -- may mean that this knockout is the one that is triggered," said Buckley.
Buckley said that although his forecast for the first rise in interest rates was now put back to the end of 2015, this was not as far as the BOE's own forecast of as late as 2016/17.
There was uncertainty over how quickly unemployment would fall, and this could see rates rising even sooner, he added.
Dr. Howard Archer, chief British and European economist with IHS Global Insight, said, the Forward Guidance policy could see interest rates rise sooner than might be expected from the BOE's figures on employment.
He said, "Much could depend on how many people return to the labor market as economic activity picks up. While this would not necessarily mean that the BOE would start raising interest rates in late-2015, it does highlight the fact that differing economic forecasts have different implications for when interest rates could start to rise."
He added, that given the surprising strength of the labor market in recent times he expected the unemployment rate to fall to 7.0 percent by late-2015, which is up to a year ahead of the BOE's expectations.
