BOE's Bean: Markets Don't Get Rate Pledge

Updated Oct. 22, 2013 7:19 a.m. ETLONDON—Investors and traders have failed to understand that movements in the Bank of England’s benchmark interest rate will be driven purely by domestic economic developments and not the actions of the U.S. Federal Reserve, a senior Bank of England official said Tuesday, in the central bank’s latest defense of its “forward guidance” strategy.

Mark Carney, governor of the Bank of England, left, and Charles Bean walk after a meeting in Washington, D.C., on Oct. 11. Bloomberg News

Charles Bean, deputy governor for monetary policy at the U.K. central bank, said in a speech in London that short-term interest rates in the U.K. continue to move more or less in lock step with those in the U.S., despite diverging economic outlooks and a pledge by the BOE not to touch its benchmark rate in the U.K. until unemployment falls significantly.
“Market participants may have not yet grasped the extent to which decisions over the level of Bank Rate will be driven by the domestic outlook,” Mr. Bean told the Society of Business Economists’ annual conference, referring to the BOE’s benchmark rate.
Mr. Bean’s comments underline the difficulty faced by many central banks around the world in charting their own course at a time when the Federal Reserve’s future actions are the dominant concern for investors. From June, central banks in many developing countries were forced to raise their interest rates in order to limit a withdrawal of capital prompted by the expectation that the Fed would soon start to reduce the amount of monthly stimulus it provided to the economy. That pressure eased in September, when the Fed surprised investors by not announcing a reduction in its stimulus program.
In July, both the BOE and the European Central Bank issued unprecedented statements on their future policy intentions. The BOE followed that up with an August pledge not to raise rates until unemployment in the U.K. drops to at least 7% from a current rate of 7.7%. Officials believe it could take until 2016 to reach that goal, but say rates could rise earlier if inflation looks set to accelerate.
Yet investors continue to expect a rise in U.K. interest rates much sooner, perhaps in 2015, fueling criticism that the BOE’s rate-pledge strategy hasn’t worked.
Mr. Bean defended the policy, saying surveys suggest households and businesses are getting the message that interest rates will stay low until the domestic recovery is secure, even if investors take a different view.
Mr. Bean said that policy of forward guidance hadn’t as yet been entirely successful in helping to “decouple” U.K. and U.S. interest-rate movements, as was intended. He is the second senior BOE official in less than a week to stress that U.K. and U.S. interest rate moves aren’t tied together.
In a speech released Wednesday, BOE Chief Economist Spencer Dale said that while interest rates in the two countries have tended to move together in that past, that is unlikely to be the case in the immediate future because the paths of the two economies have diverged. He said that while the U.S. economy has grown for almost four years and is now 5% larger than it was before the crisis, the U.K. economy has grown for just six months, and is 3% smaller.
Mr. Bean did acknowledge that investors’ expectations for the timing of a first rate hike had been influenced by a recent run of data releases that have been more positive than anticipated.
“The forward guidance plan is the biggest departure in communication since the BOE was given the independence to set interest rates in 1997 so it’s natural that both the central bank and markets are finding their way through the change,” said John McNeill, investment manager at Kames Capital, which manages £52 billion of assets. “There will some disconnect between what the BOE is saying and what markets are pricing in if incoming data continue to be strong but I would not say that tensions in money markets are huge currently.”
Mr. Bean said the 7% unemployment rate is a threshold that would prompt the Monetary Policy Committee to consider whether a rate hike was needed, rather than a “trigger” that would automatically prompt action. Indeed, he said the MPC might decide to set an even lower unemployment rate as a condition for tightening policy.
“If it appears that there is still a substantial degree of slack in the economy which can be absorbed without threatening the achievement of the 2% inflation target in the medium term, then there will be scope to maintain the existing stance of monetary policy longer, perhaps resetting the unemployment threshold to a new lower level at the same time,”
Mr. Bean said that as the unemployment rate nears 7%, the MPC is likely to “provide further guidance on the future determinants of policy in order to reduce any uncertainty surrounding our reaction function.”
Mr. Bean said the U.K.’s economic recovery appears to be gaining traction but growth may be modest by historical standards. Official figures released Tuesday provided further evidence that a recovery is under way, with the Office for National Statistics reporting that tax revenues in September were up 7% from the same month last year, reflecting higher levels of house purchases and consumer spending. That will help the government to cut its still large budget deficit.
He said he doesn’t see any signs of a property price bubble in the U.K. but said that BOE officials can’t afford to be complacent about the threat of one developing. Critics of government housing policies say they risk stoking prices without adding new homes.
—Neelabh Chaturvedi contributed to this article.
Write to Jason Douglas at jason.douglas@wsj.com

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