News Column

Interest rates Jobs boost does not mean borrowing cost rise is on way, says Larry Elliott

January 23, 2014

Larry Elliott

Unemployment is falling fast. The jobless rate is currently 7.1% and will hit the Bank of England's threshold for contemplating an interest rate rise next month. Does this mean that Threadneedle Street seriously underestimated the strength of the labour market? Yes it does. Will Mark Carney have to announce a change to the Bank's forward guidance strategy next month? Yes he will. Is an increase in the cost of borrowing imminent? No it isn't. Let's take those points one by one. Back in August, when Carney announced forward guidance, the Bank said by early 2016 there was still a 50% chance that unemployment would be above 7%. By November, the Bank thought the jobless rate would get to 7% by 2015. Now it looks like the data out next month will reveal it did so by the end of 2013. It was, to put it mildly, a big forecasting error. As to what Carney does now, it would be daft to expect the governor to junk the big policy change he initiated after taking over from Mervyn King in the summer. Nor does it seem all that likely that after just six months, Carney will move to the much looser form of forward guidance where policymakers gauge whether the economy is strong enough to withstand higher rates. Instead, the most likely outcome is that the 7% threshold will be dropped to 6.5%. That would leave the principle of forward guidance intact while adjusting to changed circumstances. The final issue is whether interest rates will rise in the near future. Certainly, the strength of job creation has led to speculation in the financial markets that the Bank will move before the end of 2014, but for now the MPC will hold rates at 0.5%. There are two big reasons for this. The first is that rising employment has so far had no impact on inflation. Annual average earnings growth is still running at less than 1%, while the government's preferred measure of the cost of living has just fallen to its 2% target. Unless and until there is evidence that falling unemployment is affecting the outlook for inflation, the Bank will see no need to risk jeopardising what it believes to be a still fledgling recovery. The second issue is that none of the other major central banks is thinking about raising borrowing costs. If Threadneedle Street led the pack, it would risk driving up the value of sterling, making UK exports less competitive. Given that the recovery has started with Britain running a current account deficit of 5% of GDP, a stronger pound would not be welcome.

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Source: Guardian (UK)

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