Policy decision: The MPC voted unanimously to leave the Bank rate at 0.5% and the target for the asset purchases unchanged at GBP 375bn. However, Weale voted against the proposal to provide forward guidance. Although he supported the adoption of the instrument he preferred a shorter time horizon than the 18-24 months related to the inflation knock-out condition, as that would make clear guidance was fully compatible with the commitment to meet the 2% inflation target in medium term.
Outlook on growth, inflation and unemployment: Developments in the domestic economy had been positive as survey indicators had risen more strongly than expected. The revival in growth had partly been driven by a pickup in private consumption, as retail sales had strengthened and consumer confidence improved. According to Minutes it was also plausible the pick-up reflected reduced uncertainty and easing credit conditions, which could support business investment going forward. The currently high inflation rate was seen as transitory and related to higher import prices and administered prices, while the underlying price pressure remained low. Therefore the MPC expected inflation to edge lower towards the 2% target over the forecast horizon.
On forward guidance: The Committee discussed a range of indicators related to forward guidance but felt unemployment rate was the best measure as it was reliable, less prone to revisions and well understood. Moreover it provided a measure of spare capacity. The Committee also agreed that, in the event that the unemployment threshold was reached, or if any of the knockouts were breached, there should be no assumption of an immediate, automatic change to its policy stance.
Monetary policy implications: Minutes from the July/Aug meeting does not change the outlook for monetary policy in any considerable way as we had most information in the Inflation Report last week. According to the the BOE unemployment forecast, unemployment will remain above 7% until Q3 2016. Consequently, the Bank rate will remain at its current level for three more years, i.e. longer than expected. On the other hand, the unemployment target was subject to several conditions, which may be difficult to envisage, which makes the threshold less certain. Considering Weale’s reservation in the Minutes these conditions may also change if the Committee would find it appropriate, which further increases uncertainty related to the threshold. Moreover the BOE has stated that its announcement of the new threshold should not be regarded as a promise to keep interest rates low for a particular period of time.
With stronger growth going forward and without increased productivity the current threshold value for unemployment could well be reached prior to the BOE forecast. Furthermore the Bank has notoriously failed to predict inflation, which has remained above the 2.5% knockout level for 51 out of the last 63 months. Therefore, while the BOE judges the probability that inflation will exceed the knockout level is less than 50%, previous experience suggests the chances it will are much higher.
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