The Bank of England is tipped to formally announce a forward guidance policy later this week, although warnings have been sounded that this could drive up inflation in the UK.
Economists expect the Bank to adopt to a formal policy of forward guidance on interest rates as a key policy lever when new governor Mark Carney presents the institution’s Inflation Report on Wednesday. Carney is a strong advocate of forward guidance and used his first Monetary Policy Committee meeting to reassure on the future path of interest rates.
IHS Global Insight chief UK and European economist Howard Archer says: “There seems little doubt that Mr. Carney and his MPC colleagues will want to ram home the message to businesses, consumers and the markets that any tightening of monetary policy is a very long way off, notwithstanding the recent signs of improvement in the economy.
“To this end, we are convinced that the Bank of England will formally adopt a policy of forward guidance on interest rates.”
However, University of Columbia professor Michael Woodford – an expert in forward guidance – warns that reassuring the markets that interest rates are to remain at historic lows for the foreseeable future could push inflation higher.
“If it’s too successful, maybe it then pushes up inflation more than you want, and that’s obviously a concern in the UK as the Bank of England has been overshooting its inflation target as it is,” he told the BBC.
“But the view of undertaking such a policy is that you are concerned enough about undershooting in terms of the real economy that you do in fact want more stimulus, even if it nudges up inflation a little bit as the price of getting it.”
Woodford singles out the way Carney introduced forward guidance when he was governor of the Bank of Canada as “a little dangerous”, as he announced that interest rates would stay low until a specific date.
“The ideal thing would be to talk about specific economic conditions and say interest rates will stay where they are until certain conditions that are not currently satisfied are reached. And to define those conditions in such a way that if inflation did start shooting up faster than you expected, then that would bring the date forward,” he says.
UK consumer prices index inflation has remained above the Bank’s 2 per cent target since December 2009. The latest official figures show CPI stood at 2.9 per cent in June.