Analysts expect the Bank of England Monetary Policy Committee may use Wednesday’s May Quarterly Inflation Report and accompanying press conference to steer markets back toward a focus on its inflation forecasts, and away from th forward guidance fixation on its jobless projections.
With near term inflation projections set to be pushed lower, the focus on prices should send a fairly dovish message. Some analysts, however, believe that Governor Mark Carney will use the ensuing press conference to leave the door open to an earlier hike, while insisting that any eventual rises in Bank Rate will be gradual.
Bank Rate has now spent over five years at its record low of 0.5% but a steady flow of interviews and speeches show the MPC in no rush to tighten policy despite the economy growing at an above-trend pace and burning off spare capacity as it nears its pre-crisis apex.
While some believe the chances of an earlier rate hike have risen, most analysts spoke to dismissed talk of a potential November hike, noting that the headline inflation forecasts appear unlikely to change significantly between now and then.
CPI, at 1.6% y/y in March, is below its 2% target and plenty of slack remains in the labour market, according to Governor Mark Carney.
Some analysts believe that markets dwell too much on the labour data flow and they should instead look to the smoke signals rising from the inflation forecasts.
“As much as the city chattering classes obsess over various employment measures or measures of labour market tightness, ultimately, the clearest policy signal comes from the inflation forecast,” Ross Walker, Chief UK Economist at RBS.
“Experience in the US and Britain has shown that a simple measure of the labour market is not a sufficient tool to gauge the amount of spare capacity in the economy,” he added.
Back in its February QIR, the MPC estimated there was around 1-1.5% of GDP of spare capacity left to burn off in the economy before growth starts pushing up on inflation.
Most of that slack is centred in the labour market, the MPC believes. Unemployment still stands above the MPC’s estimate of an equilibrium rate of 6-6.5%, hours worked are still way below pre-crisis levels and a persistent participation gap remains.
Carney has also pointed to rapid growth in self-employment and a high number of people wanting to work more hours as other potential sources of labour supply.
Others on the committee disagree, believing that jobs slack is evaporating and there is a debate over the importance of the large numbers of self-employed workers. The rise in self-employment is, for example, partially due to self-employed builders returning to work to meet the demand from a hot housing market.
The Inflation Report is likely to explore the issues of self-employment further.
Carney may use the ensuing press conference to give further colour to what he thinks are additional indicators of slack, but a caveat here is that Carney is at the outer end of the MPC spectrum in his views on how much slack there is.
Walker believes the CPI forecast is key and that it will show the MPC retains a dovish bias. CPI has undershot the MPC’s February QIR forecasts with annual price rises averaging 1.73% in Q1, as opposed to the 1.83% the MPC forecast in its February Inflation Report.
Others agree, and those forecasts could even shift lower, according to Investec’s Chief UK Economist Phil Shaw
“We’ve had something like a 1 percentage point increase in the trade-weighted index of sterling over the past three months so, if anything, you might expect the MPC to shift down its expectations of inflation over the next 2-3 years,” Shaw says.
Weaker inflation forecasts would augur against a sooner-than-expected rate hike, which markets currently believe will happen at some point in Q1 2015.
Nevertheless, Carney and colleagues will be careful not to come close to ruling out an earlier hike: with the economy growing fast there is a possibility earnings growth could, and maybe is already, accelerating sharply,
“The BoE will be mindful that it may need to raise rates later this year: the unemployment rate is falling quickly, and there are early signs that pay growth could start picking up more rapidly,” Allan Monks, UK Economist at JP Morgan noted.
“This risk is likely to prompt a more subtle shift in BoE rhetoric tomorrow: rather than investing much time in arguing that rates are unlikely to rise for some time, we expect Carney to instead place the emphasis on the likely path of higher rates when tightening does commence – i.e. reiterating that policy tightening will occur gradually,” Monks added.