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News Analysis: Spare capacity in economy key to British central bank policy

English.news.cn   2014-04-24 07:29:35

LONDON, April 23 (Xinhua) -- The shape of British central bank monetary policy over the coming months will be largely dependent on the rate at which the slack in the economy can be used up.

The Bank of England (BOE) Wednesday revealed the minutes of its latest Monetary Policy Committee (MPC) meeting held at the beginning of the month, which showed a growing debate about how much spare capacity there is in the economy.

The MPC showed an unsurprising unanimity among its nine members to keep the bank rate at its historical low of 0.5 percent, as markets and commentators had expected.

But the debate over how much spare capacity there is, is now an important one.

This follows evidence at a Treasury Committee on March 11 on February's Quarterly Inflation Report, when MPC member Martin Weale said he believed that the amount of spare capacity in the economy was probably "something under 1 percent."

Governor Carney said in another Parliamentary committee that he believed spare capacity was at the upper end of the 1.0-1.5 percent range which is the BOE's current estimate, and that it could be even higher still.


With the British economy set for 3.3 percent growth this year, in the BOE's own model, it's clear a rate rise is on the horizon, but the question markets, businesses and householders ask is "when?"

Last August a falling unemployment rate was targeted by the BOE as the key indicator for a rate rise. Under Forward Guidance policy, 7 percent was set as the threshold at which the rate would be reviewed.

The jobless rate was 7.8 percent at the time, and has fallen faster than the BOE expected. This month it hit 6.9 percent, for the three months to February, but that was after the MPC meeting at the beginning of the month.

However, the sharp fall has increased calls for a rate rise before the end of the year, and the BOE itself eased the FG policy out of the way in February and said it was targeting a wider spread of indicators.

Governor Mark Carney and his team at the BOE do not want a rate rise any time soon, and have been signaling to the market in the past weeks that there is no imminent rise planned.

Bank officials will not be drawn into a date, but commentators are pointing to a rise in 2015, with a range from Q1 to Q3 expressed.


The minutes of April's MPC meeting reveal a debate among MPC members over spare capacity in the economy, which also takes in the jobless rate. This is now a key debate which will affect the timing of a rate rise when it comes.

Slack is difficult to measure, and members expressed "considerable uncertainty" on its amount. There was also a "range of opinions" over prospects for inflation, currently 1.6 percent against a target of 2 percent, in the medium term.

The MPC was encouraged by an increase in productivity, but that data were superseded by the jobless figures this month which showed a sharp fall, driven by self-employment, which may not be the most effective way of recovering lost capacity and increasing productivity.

Indeed, if the falling unemployment rate and an improving economy allow higher wage settlements, and figures this month showed average wage rises were above inflation for the first time in six years, then wage costs will go up but productivity will not, creating inflationary pressures.

Simon Wells, chief British economist at HSBC, said that the jobless figures, and how they are made up, will likely be the source of much MPC debate in coming months.

He said, "The debate about tightening may increasingly hinge on how the MPC interprets the rise in self-employment, which was strong again in last week's data."

The minutes contain "several reasons" why higher self-employment might not reflect slack but instead be a secular labor market trend, Wells said.

He added, "This suggests that by no means all MPC members think there is a huge amount of under-employment in the UK. In this sense, we think today's minutes were perhaps slightly hawkish although, as usual, they stressed uncertainty about the amount of slack."

Whatever the shape of policy in the coming months, the BOE is likely to continue its policy of talking to the market, businesses, and households.

The BOE is likely to continue stressing that there will be no rate rise this year, and that when the Bank Rate does begin to rise it will do so gradually.

In addition, Governor Carney has gone on record to say that interest rates of 5 percent plus, seen in the years before the financial crisis, are not likely with an era of lower interest rates forecast.

Editor: An
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