UK rates: No change in 2014?

With data released last week having shown the unemployment rate in the UK falling to 7.1% in the three months to November, just a tenth of a percentage point above the MPC’s forward guidance threshold, an awful lot of rubbish has been said and written about how this highlights the failure of forward guidance in the UK. The Financial Times even went so far as to call the fact that Mark Carney will soon have to ditch the current forward guidance framework “embarrassing”.

But that could not be further from the truth - the fact that the MPC is already having to think about what to do after the unemployment rate falls to 7%, rather than the late-2015 date it thought was likely when it first announced its forward guidance framework in August, is both a cause for celebration and at least a partial vindication of forward guidance.

Of course, we will never know for certain what role the introduction of forward guidance played in driving the pretty astonishing pick-up in growth seen since spring 2013 – this was of course a period that coincided with the realisation that the euro area was not about to implode. But that can’t explain all of the acceleration in growth – the economic recovery in the euro area has come through much more slowly. It would therefore be churlish to think that Mark Carney’s appointment, and the subsequent change in policy emphasis, played no role. Certainly, as the charts below demonstrate, his appointment, and in particular his first appearance in front of the Treasury Committee, at which it became clear that a commitment to keep rates on hold was to be his first move, coincided with the abrupt upturn in the economy’s fortunes.

With the unemployment rate now on the brink of hitting 7%, the MPC needs to get its skates on to formulate what it’s going to do next. It has already told us, in the minutes of its January meeting, that "members...saw no immediate need to raise Bank Rate even if the 7% unemployment threshold were to be reached in the near future” and that "when the time did come to raise Bank Rate, it would be appropriate to do so only gradually". August’s forward guidance has therefore already been extended beyond the 7% threshold. And that evolution towards more general forward guidance, i.e. not based on a single target, looks to be what the MPC will announce when it publishes an assessment of how policy will evolve sub-7%. Certainly, comments from Mark Carney last week talking about a need to look at overall conditions in the labour market and economy more generally indicate that a move to simply lower the unemployment threshold has been ruled out. Expect, therefore, a move to a Fed-style commitment to hold rates low for a considerable time after unemployment reaches 7%. But while the MPC is likely to consider publishing Fed-style forecasts of individual members’ forecasts of how they expect Bank Rate to evolve, the relatively small size of the Committee may leave some uneasy about doing so. That may prove an evolution too far for the MPC. 

Given this, how long can we expect Bank Rate to remain on hold? Well, there are plenty of reasons to believe that it can be left where it is for a significant period yet. Notwithstanding the recent fast growth, on any number of measures the economy remains weak. It remains smaller than its pre-crisis peak, while unemployment remains relatively high and well above the MPC’s estimate of the “medium-term equilibrium rate”, which Mark Carney last week said is now likely to be below the 6.5% level previously estimated by the MPC. Investment levels, meanwhile, remain low, while productivity growth has been exceedingly weak. Finally, exceptionally weak wage growth means that real average earnings continue to fall even as inflation has fallen back to target. And even if wage growth does begin to accelerate as the recovery progresses, the weak current level of productivity should mean that there is plenty of scope for firms to raise productivity to keep a lid on price pressures. There therefore seem few, if any, immediate risks to the medium-term outlook for inflation. As such, the likelihood remains that the MPC leaves rates where they currently are right through 2014, moving to tighten only at the start of 2015, by which time we expect the unemployment rate to have fallen to a level where the MPC will start to feel that the recovery is in a position to survive a modest upward move in rates designed as the first step in the removal of highly-accommodative policy. And even then, with Mark Carney last week expressing his belief that even in the medium term interest rates will be below their pre-crisis norms, tightening will happen only very gradually. Low rates look set to be a feature of the UK economy for many years to come.

Mortgage approvals and lending

UK rates 27Jan14 mortg 1ii GLSource: Datastream and Daiwa Capital Markets Europe Ltd.

EmploymentUK rates Empl 27Jan14 2 GL

Source: Datastream and Daiwa Capital Markets Europe Ltd.

Consumer confidence and consumptionUK rates 27Jan14 GL cons conf 3Source:Datastream and Daiwa Capital Markets Europe Ltd.

Grant Lewis, Head of Research

Categories : 

Back to research list


This research report is produced by Daiwa Securities Co. Ltd., and/or its affiliates and is distributed by Daiwa Capital Markets Europe Limited in the European Union, Iceland, Liechtenstein, Norway and Switzerland. Daiwa Capital Markets Europe Limited is authorised and regulated by The Financial Conduct Authority and is a member of the London Stock Exchange and Eurex Exchange. Daiwa Capital Markets Europe Limited and its affiliates may, from time to time, to the extent permitted by law, participate or invest in other financing transactions with the issuers of the securities referred to herein (the “Securities”), perform services for or solicit business from such issuers, and/or have a position or effect transactions in the Securities or options thereof and/or may have acted as an underwriter during the past twelve months for the issuer of such securities. In addition, employees of Daiwa Capital Markets Europe Limited and its affiliates may have positions and effect transactions in such securities or options and may serve as Directors of such issuers. Daiwa Capital Markets Europe Limited may, to the extent permitted by applicable UK law and other applicable law or regulation, effect transactions in the Securities before this material is published to recipients.

This publication is intended for investors who are not Retail Clients in the United Kingdom within the meaning of the Rules of the FCA and should not therefore be distributed to such Retail Clients in the United Kingdom. Should you enter into investment business with Daiwa Capital Markets Europe’s affiliates outside the United Kingdom, we are obliged to advise that the protection afforded by the United Kingdom regulatory system may not apply; in particular, the benefits of the Financial Services Compensation Scheme may not be available.

Daiwa Capital Markets Europe Limited has in place organisational arrangements for the prevention and avoidance of conflicts of interest. Our conflict management policy is available at  /about-us/corporate-governance-regulatory. Regulatory disclosures of investment banking relationships are available at