Backward guidance

13 August 2014 By George Hay Follow @gfhay

The central bank has conceded the economy still contains slack, despite plummeting unemployment. It is easy enough to tweak wage growth assumptions that already looked way too bullish. Keeping investors interested in following BoE guidance will be rather harder.

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The Bank of England has cut its assumptions for wage growth in the UK economy in 2014 from 2.5 percent to 1.25 percent.

The central bank said on Aug. 13 that it was revising its forecast for GDP in 2014 up to 3.5 percent from 3.4 percent at its last inflation report in May. It also said that spare capacity, or slack, was now 1 percent, compared to a 1 percent to 1.5 percent range before.

But the BoE revised down its estimate of medium term unemployment from 6 to 6.5 percent to 5.5 percent. It assumes productivity will now grow by only 0.25 percent this year, against previous forecasts of 1 percent.

BoE governor Mark Carney cited rises in total hours worked, falls in unemployment, and the highest labour participation rate in almost 25 years as evidence of declining slack. But the bank also said there was greater uncertainty around the level of slack than in May, and suggested there had been an increase in labour supply at a given wage rate, especially among older age groups.

Carney said the BoE’s Monetary Policy Committee would be placing particular attention on the prospective paths for wages and unit labour costs, but reiterated that future changes in the bank’s benchmark interest rate would be gradual and limited. However, he added that this was an expectation, not a promise.

Carney stated that muted demand in UK export markets and ongoing balance sheet repair meant that even if slack were to be completely eroded, the appropriate level of bank rate would be not far from its current position.

Sterling fell from 1.6842 against the dollar to 1.6701 as of 1530 BST on Aug. 13.

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