Carney broadens forward guidance with extra slack

Guidance within guidance

The BoE succeeds in issuing sharply upward revisions in its 2014 GDP forecasts to 3.4% from the prior 2.8% estimates without boosting bond yields by unveiling additional guidance aimed at keeping interest rates low despite continued declines in unemployment.

Carney has not only preserved the original forward guidance of 7.0% unemployment threshold, but further strengthened it by issuing additional guidance once the unemployment threshold is attained.

The introduction of the more complex metric of spare capacity shifts emphasis away from the easier-to read 7.0% unemployment threshold, and buys the BoE more time before being forced into pulling the interest rate trigger prematurely.

The spare capacity metric will be assessed with respect to labour markets as a way to address any margin of error in the unemployment rate. The number of unemployed as well as hours of employment will both be key in determining spare capacity.

Just as Bernanke spent most of 2013 in drawing attention to slack and structural weakness in labour markets as a way to suppress bond yields, Mr. Carney is following a similar path by using a more nuanced approach in focusing on labour markets, without necessarily jeopardizing the BoE’s credibility. Such a policy may not be inflationary as long as sterling preserves its “structural” robustness.

Sterling’s upward momentum may be tempered by the BoE’s credible justification for standing pat on rates despite unemployment reaching its 7% unemployment.

The introduction of spare capacity sub-guidance may stand in the way of private economists speeding their forecasts for the next rate hike, but sterling will find support (near $1.58) as long as the BoE’s policy accommodation greases the wheels of the ongoing recovery and maintains the UK’s relative growth story.

Rather than engaging in GBP momentum plays above 1.6550s, we prefer to wait for pullbacks towards 1.6300 for renewed longs back near 1.6600.