Carney Enhances Forward Guidance – GBP/USD jumps

The Inflation Report by the Bank of England is certainly supportive of the pound. Carney is praising the Forward Guidance but also adopts a cautious stance. No change to forward guidance is seen in the report, but Carney outlined

GBP/USD was trading at around 1.6490 towards the publication of the report, rising from lower ground. After the publication of the report and as Governor Mark Carney begins speaking, the pair is already at 1.6530. It reached a peak of 1.6538 before falling and rising once again. Update: the pound touched 1.6548.

Markets are now expecting the BOE to raise rates in Q2 2015, and Carney did not reject this. In Phase I  of forward guidance, the Bank expected rates to remain unchanged until 2016.

While FG is not “time contingent”, the acceptance of market expectations implies rate hike expectations moving forward. The phrase “market interest rate expectations” appears 3 times in the report.

Some of what Carney says:

• There still is spare capacity in the labor market
• Inflation is more benign than expected.
• Sterling has appreciated by 10%.
• Recovery not sustainable just yet.
• Wage growth remains weak.
• Household saving is low.
• The growth in productivity has been disappointing.

5 Elements to new guidance:

• Seeking to absorb the spare capacity in the next 2-3 years.
• If and when the time comes to sustain higher rates, it will rise only gradually.
• Level of stimulus to remain exceptional.
• MPC will examine many many factors.
• Any increases in bank rates will be limited.

More:

• Publishing forecasts for 18 indicators.
• One illustration is a forecast for 2% interest rate in 3 years.
• QE to be maintained up to the first rate hike.

Waiting to absorb spare capacity before rate rises.

The Bank of England now sees GDP growth of 3.4% in 2014 and 2.7% in 2015. The strength of sterling is a challenge.

The MPC will not take risk with the recovery.

In the August 2013 Inflation Report, Mark Carney introduced his signature policy: forward guidance. The Bank pledged to keep rates low as long as the unemployment rate remained above 7%. Carney and co. expected unemployment to drop gradually and saw a rate hike only in 2016.

However, the unemployment rate dropped to 7.1% and this raised the pressure on Carney for a change in policy. On the other hand, the drop in inflation to 2.1% certainly allows for breathing space.

For more on the pound, see the Pound dollar forecast.