Moments ago the Bank of England's Mark Carney, very much as expected and warned previously, announced for the first time as part of the BOE quarterly Inflation Report press conference [7](the full August inflation report can be found here [8]) the official linkage of monetary policy outlook to unemployment and pledged to expand stimulus if needed as he tried to quell investor bets on higher interest rates. Specifically as part of the BOE's forward guidance, Carney linked interest rates to a 7% unemployment threshold while forecasting that unemployment would be higher than 7% until at least Q3 2016, or in other words, no threat of an end of extraordinary monetary policy any time soon.
However, while the market enjoyed the announcement initially and sent cable 100 pips lower to 1.52, the initial dovish mood was quickly reversed after the market observed that Carney's statement carried with it three "knock out clauses" which made the forward guidance far less explicit and put doubts into the market about the credibility of this latest monetary experiment as a result unwinding an initial 100 pip drop in cable and sending it over 200 pips higher from the lows.
Specifically:
- the policy stance will depend on economic conditions, and will also be determined by the BOE's inflation target which remains at 2%
- the BOE's guidance won't hold if the CPI is seen 0.5% over 2% in the next 18-24 months
- the guidance won't hold if the BOE's council sees a financial stability threat
- Carney refrained from overlooking the BOE's inflation mandate and reiterated the bank's commitment to price stability.
- Carney said that a prolonged period of low rates has stability risks, and added that the UK economy will undoubtedly face shocks in the future which further detracted from the credibility of forward guidance
- Finally, the BOE forward guidance is not a change in the bank's reaction function Carney clarified.
The combination of all these "credibility-questioning" clauses promptly unwound the initial currency weakness, and promptly sent the GBPUSD soaring over 200 pips in the opposite direction as some saw Carney's remarks as far less of a "commitment" than previously expected.
[9]