Inflation down, unemployment down, recovery under way. Time to panic?

There was a predictable hullaballoo following the publication of the Bank of England’s inflation report revealing a sudden drop in inflation to 2.2% and Governor Carney’s statement that the Bank now expects unemployment to fall to 7% more quickly than previously thought. Interest rates about to through the roof then, eh?

The 7% unemployment threshold is, of course, the tipping point for the Bank’s forward guidance: the point at which an increase in Base Rate becomes thinkable. When the new policy was announced back in August the Bank estimated it could take as much as three years for unemployment to drop to 7% – and even then there’d be no guarantee of an immediate rate rise - apparently giving reassurance that low rates were here to stay for a fair while at least.

At the time many economists said that was unduly pessimistic, which now seems to have been borne out. Mind you, I can’t help recalling that said economists have been lambasting the Bank’s forecasting abilities for, gosh, years now. So their sudden willingness to accept this forecast (which they happen to like) might carry a slight whiff of selectivity.

Be that as it may, should we now expect Base Rate to go up next year?

Well here’s what Mark Carney actually said: “Based on the assumption that Bank Rate follows market interest rates, we judge there to be a two in five chance that unemployment will reach the 7% threshold by the end of next year, and a three in five chance that it will have done so by the end of 2015.”

To unpick that “Based on the assumption that Bank Rate follows market interest rates” you have to dig into the inflation report to find the Implied Forward Market Interest Rates (which in case you’re wondering is academic-speak for What People Reckon), showing base rate as 0.5% throughout next year, increasing gradually to 1.00% over 2015 and then to 1.5%-1.75% by the end of 2016

Or to put it another way: so long as they don’t increase Base Rate next year, odds are they won’t have to think about increasing Base Rate next year!

Or to put it another way: probably not.

Though with a capital “probably”.

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