Unemployment forces rethink on forward guidance

Employment surge will force rethink on forward guidance …
The governor went to Davos this week and also appeared on the Paxman Show. He was asked about unemployment, forward guidance and Bitcoins! Excellent.

Unemployment
Unemployment fell to 7.1% in the three months to November according to the latest data from the ONS. Over 30 million were in employment up by 280,000 on the prior three months. Good news for the economy and a measure of the strong recovery in the UK, particularly in the second half of the year.

The claimant count measure fell by 24,000 to a rate of 3.7%. The unemployed (claimant count) will fall below the one million mark by the end of 2014 based on our current forecasts. This would be in with levels last seen in September of 2008.

No need then to worry about household incomes, earnings will begin to recover significantly as the job market tightens through the year.

Forward Guidance
So what of forward guidance? “Mark Carney has torn up his original low interest rate policy after completely misjudging the speed at which unemployment would fall” according to Phillip Aldrick writing in The Times today. Well not really. It is true the Bank of England model assumed the 7% hurdle rate would be triggered in 2015 rather then by the end of 2013!  

Nevertheless, the overall parameters of forward guidance remain in tact. The major concern of central bankers is conditioned by the experience of The Great Depression and the Lost Decade. Monetary policy will remain accommodating until the recovery and “escape velocity” from recession is secured. Even then, rates will rise slowly and  gradually. It will be some years before a return to equilibrium base rates of 4.5% is achieved, the additional guideline.

In the Inflation Report due next month, the bank will consider a range of options to update  Forward Guidance. The simplest solution, an update to the unemployment hurdle rate from 7% to 6.5%. The challenge of a more complex hybrid may prove irresistible.

As for escape velocity, tapering in the US is expected to accelerate. There seems little justification, if indeed there ever was, to continue to spend Fed dollars on US Treasuries and mortgage debt. 3% growth in the USA economy appears possible this year. That’s a faster rate than in the years leading up to the collapse in 2008.

Borrowing Figures
The UK Government borrowing figures were released this week. The government is on track to reduce the level of borrowing to between £105 billion and £110 billion this year. Receipts are rising faster than spending and the overall level of borrowing in the first nine months of the year is down by over £5 billion.

Inflation down, borrowing down, unemployment down, earnings will begin to rise later this year. The platform for the election is well set. Just the trade figures alone will continue to disappoint as problems in Europe persist.  

So what happened to sterling?
Markets were disturbed by the possibility of more tapering, undermining stock market strength in the USA and destabilizing international capital flows across developing economies. Poor readings from manufacturing data in China and Japan, plus problems with the Argentinian peso created the “perfect storm” for markets at the end of the week.

The CBOE Vix volatility index shot up from 13.8 to 18.14 at close. Some way off the 55 level recorded in the depths of despair in 2010 but a measure of late volatility nevertheless.

The pound closed at $1.6481 from $1.6422 against the dollar and 1.2041 from 1.2127 against the Euro. The dollar closing at 1.3681 from 1.3538 against the euro and 102.34 104.23 against the Yen.

Oil Price Brent Crude closed at $107.88 from $106.48. The average price in January last year was almost $113, so no real threat to inflation from crude oil prices

Markets, moved down - The Dow closed at 15,879 from 16,458 and the FTSE closed at 6,663 from 6,829. 7,000 on the FTSE a soft call for the near term, requiring a little more work in progress.

UK Ten year gilt yields closed at 2.78 from 2.84 and US Treasury yields closed at 2.72 from 2.82. Yields will test the 3% level as tapering accelerates into 2014 but for this week, the flight to quality led the market.

That’s all for this week. No Sunday Times and Croissants tomorrow or for the rest of this year for that matter. We are taking a break in this pre election year.

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John
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