UK guidance: rate commitment hinges on questionable productivity rebound
Simon Ward
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As expected, the MPC has introduced Fed-style policy guidance based on a threshold for the unemployment rate but with inflation and financial stability “knock-out” clauses . The 7% level of the threshold, however, is higher than many commentators predicted, explaining a negative market reaction.
The MPC’s central expectation is that unemployment will remain above the threshold through late 2016 but market participants have given this little weight, partly reflecting the Committee’s poor forecasting record. The view here is that the jobless rate will fall significantly in response to the current growth pick-up, with a breach of the threshold likely by mid-2014 – see previous post.
The table below, taken from the forward guidance documentation, shows illustrative projections for the unemployment rate in three years’ time for different combinations of GDP and productivity growth. The MPC’s central forecast is that GDP will rise by 2.5% per annum over this period. Its expectation that the unemployment rate will be a little above 7%, therefore, assumes that productivity will increase by 1.5-1.75% pa.
Such performance, however, would be stellar by recent standards. Productivity grew by only 1.0% pa in the 10 years to 2012; it was stagnant between 2009 and 2012.
The additional rows at the bottom extend the analysis to allow for weaker productivity performance – their omission from the published table is strange. A growth rate of 1.0% pa in conjunction with the Bank’s forecast of 2.5% GDP expansion would imply an unemployment rate of only 5.5% in three years’ time, versus 7.8% currently. Such a decline would be consistent with it hitting the 7% threshold a year out.
The prospect of an early and significant fall in unemployment suggests that, far from anchoring interest rates far into the future, the new framework will force the MPC to tighten policy sooner than implied by recent time-based guidance.
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