BoE appraises forward guidance as economy picks up

The Bank of England's Monetary Policy Committee (MPC) is upbeat about the prospects for the UK economic recovery and believes its forward guidance is starting to hit home, according to the minutes from its September meeting.

The minutes show unanimity among the nine members over keeping the bank's key interest rate at 0.5% and the stock of its asset purchases at £375 billion, and that none of the knockouts for its forward guidance had been breached.

The committee is optimistic that economists and market participants have displayed an "increased understanding" of the bank's intention to link monetary policy with unemployment. Nonetheless, it acknowledges the need to improve the public's understanding of how the 7% unemployment threshold would work in practice.

The minutes show the MPC making the point emphatically that its 7% threshold for the unemployment rate is "not a ‘trigger' that is mechanically linked to subsequent movements in bank rate".

Many of the committee members have appeared at public events since the introduction of the guidance, including a high-profile hearing with the UK parliament's Treasury Select Committee in which Carney rebuffed accusations that markets doubt the Bank of England's commitment to its new policy set-up.

One member, David Miles, attempted to defend the rationale behind the bank's forward guidance at the Money Macro and Finance Conference hosted at Queen Mary University of London last week.

He explained the bank is attempting to reveal more information about its "reaction function" in the hope of dampening expectations that the MPC will hike rates as soon as the UK recovery gathered pace.

He insisted "the essence of forward guidance is relatively straightforward" and branded some of the media interpretations of the bank's forward guidance as "bizarre". A number of media outlets have misrepresented the guidance as a pledge to keep rates low until 2016.

The danger of this, as pointed out by a member of the audience, is that less economically literate members of the population could enter into long-term contracts, potentially in the housing market, as a result of this mistaken belief.

Miles continued to repeat a line about the Bank of England reaction function and insisted the concept is simple enough for the public to understand. He argued that it is "premature" to evaluate the impact of the guidance after such a short period of time.

In the audience, Shelton Nicholls, a former deputy governor at the Central Bank of Trinidad and Tobago, raised his own concerns over central bank communication.

He suggested the real difficulty facing central banks is not convincing the public of a particular policy path, but convincing them that monetary policy can have any significant impact on the economy to begin with.

"In many ways the public perception is that monetary policy cannot in fact play that role," Nicholls said. "Nothing you say to the public sometimes can convince them that targeting inflation – lowering inflation – will do anything for growth or unemployment."

The minutes also reveal the committee discussed the recent growth in the UK housing market, with its members suggesting the recent pick-up in activity could boost growth and that "some" rise in prices "might provide a modest fillip" to consumer spending and investment.

"Nevertheless, the committee noted that property market developments would become more of a concern if a period of rapid real house price increases appeared in prospect," the minutes say.

The committee highlighted that the Bank of England's Financial Policy Committee (FPC) and Prudential Regulatory Authority (PRA) both had "a range of instruments" they could employ in such a scenario. The FPC met earlier today and will release a statement summarising its discussions and any policy changes on September 25.