Divyang Shah on the importance of spare capacity in guiding Bank of England monetary policy.
It was in last month’s Inflation Report that the BoE told us that spare capacity was between a 1.0%–1.5% range.
But yesterday we heard that BoE governor Carney thought that spare capacity was slightly higher than 1.5% while MPC member Weale estimated it at below 1.0%.
These differences are important and suggest that during Q2/Q3 2014 we will start to see noticeable divergence in opinion on when to start the tightening cycle.
Forward guidance II for the BoE has two important elements:
1) a signal that rates won’t be raised until it feels that all the spare capacity in the UK economy will be used up, and
2) rate hikes when they occur, will be gradual and limited.
Key to the timing of a rate hike is the very difficult to define and subjective view on spare capacity. The BoE had given us the impression that there was very little disagreement on spare capacity within the MPC, now this might not be the case.
The 1.0-1.5% range provided in February’s Inflation Report, however, does not seem to be where the truth lies judging by the TSC hearing on the Inflation Report yesterday. Carney has put himself on the dovish end of the spectrum while Weale is (predictably) more hawkish.
Remember that back in February, Martin Weale had been the only MPC member to offer any thoughts on a tightening timetable when he stated that he could see rates could go up sooner than the second quarter of next year if wages rose quickly.
But what is worrying is that neither the Inflation Report nor the minutes revealed such differences of opinion on spare capacity. This suggests that the Inflation Report and minutes are there to support the BoE’s communication as opposed to being a real guide to the thinking of individual MPC members.
The practice of destroying MPC meeting records, leaving just the published minutes, means that we won’t know what really went on behind closed doors. Given the advancement in technology and digital storage options it is difficult to defend the BoE’s inability to release FOMC style minutes after a lag.
This controlled transparency means that we have to keep an eye on individual member speeches to gauge any shifts in views, with official releases used to strengthen the consensus view on policy. Weale and Dale still seem more likely to provide insight into the timing of the first rate hike compared to other neutral/doves.