Bank of England forecasts move more than credibility demands

The Bank is still underestimating the strength of the recovery - and its latest report, puzzlingly, contained large changes to its expectations for both unemployment and inflation.

Regular readers of this blog will know that I’ve always had a theoretical problem with forward guidance. Telling people that rates are going to stay lower for longer can have two undesirable consequences, ironically of a diametrically opposed nature. On the one hand, some people will think that if the Bank of England has such a downbeat assessment of the economy and its prospects, then they had better put off that purchase or that investment which they were planning. At the other end of the spectrum, some people will borrow far more than they should, because they believe the rate guidance, and we all know what will happen if the guidance is "wrong" and interest rates go up much sooner and faster.

But, I hear you say, surely the Bank of England has the finest brains at its disposal and its forecasts will therefore be rather accurate. Mmm, well no, not usually. In fact hardly ever, if their performance with regard to inflation forecasting is anything to go by. Mark Carney’s predecessor, Sir Mervyn King, was forced to write no fewer than 14 explanatory letters to Chancellors, starting with Gordon Brown in 2007, explaining why inflation had risen above 3 per cent, when the Bank’s target was 2 per cent. Now that refers to actual inflation outcomes, rather than forecasts, but forecasts presumably play a significant role in helping the Bank achieve its objectives, as monetary policy must usually, by definition, be set with a medium-term perspective.

The Bank’s latest Inflation Report contained really very large changes to its expectations for both unemployment and inflation. Let’s compare this report to the previous one, released in August. At that time the median prediction was that unemployment would still be 7.3 per cent in Q32015, but in the November Report, "The Committee’s latest projections, assuming that Bank Rate rises in line with the market curve, imply around a two-in-five chance that the unemployment rate will havereached the 7 per cent policy threshold (for rate rises) by the end of 2014. The corresponding figures for the end of 2015 and 2016 are around three in five and two in three respectively." This represented a shift forward in time of nine months for the time at which we might reach the 7 per cent threshold.

There is also a key phrase in that quote on which one should focus: "assuming that Bank Rate rises in line with the market curve". So, even this new optimism is based on an expectation that rates will rise above 0.5 per cent before then, as predicted by the market’s interest rate curve, but in a recent speech (in Nottingham) Carney told us that the only thing that effected the economy was the overnight rate and that it certainly wasn’t going to rise until unemployment was down to 7 per cent, so surely even this revised forecast of when we might reach the threshold is still actually pessimistic?

In the real world Carney may feel that forward guidance, and its initial implied assurance that rates were going to stay low for a long time, has managed to retain some of its credibility because the Bank also had to dramatically lower its forecasts for the near-term path for inflation-which it now projects will be 0.7 per cent lower in Q42013 than it did just in August. It also lowered from 42 per cent to 33 per cent its view of the probability that CPI will be above the 2.5 per cent "knockout" in 18-24 months time.

All-in-all, I retain my suspicion that forward guidance is a flawed policy. The Bank is still underestimating the strength of the recovery and I have even greater fears for its credibility in the light of these rapid and sizeable changes to its forecasts.

Mark Carney said recently that the only thing affecting the economy was the overnight rate. Photograph: Getty Images.

Chairman of  Saxo Capital Markets Board

An Honours Graduate from Oxford University, Nick Beecroft has over 30 years of international trading experience within the financial industry, including senior Global Markets roles at Standard Chartered Bank, Deutsche Bank and Citibank. Nick was a member of the Bank of England's Foreign Exchange Joint Standing Committee.

More of his work can be found here.

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The problems with ending encryption to fight terrorism

Forcing tech firms to create a "backdoor" to access messages would be a gift to cyber-hackers.

The UK has endured its worst terrorist atrocity since 7 July 2005 and the threat level has been raised to "critical" for the first time in a decade. Though election campaigning has been suspended, the debate over potential new powers has already begun.

Today's Sun reports that the Conservatives will seek to force technology companies to hand over encrypted messages to the police and security services. The new Technical Capability Notices were proposed by Amber Rudd following the Westminster terrorist attack and a month-long consultation closed last week. A Tory minister told the Sun: "We will do this as soon as we can after the election, as long as we get back in. The level of threat clearly proves there is no more time to waste now. The social media companies have been laughing in our faces for too long."

Put that way, the plan sounds reasonable (orders would be approved by the home secretary and a senior judge). But there are irrefutable problems. Encryption means tech firms such as WhatsApp and Apple can't simply "hand over" suspect messages - they can't access them at all. The technology is designed precisely so that conversations are genuinely private (unless a suspect's device is obtained or hacked into). Were companies to create an encryption "backdoor", as the government proposes, they would also create new opportunities for criminals and cyberhackers (as in the case of the recent NHS attack).

Ian Levy, the technical director of the National Cyber Security, told the New Statesman's Will Dunn earlier this year: "Nobody in this organisation or our parent organisation will ever ask for a 'back door' in a large-scale encryption system, because it's dumb."

But there is a more profound problem: once created, a technology cannot be uninvented. Should large tech firms end encryption, terrorists will merely turn to other, lesser-known platforms. The only means of barring UK citizens from using the service would be a Chinese-style "great firewall", cutting Britain off from the rest of the internet. In 2015, before entering the cabinet, Brexit Secretary David Davis warned of ending encryption: "Such a move would have had devastating consequences for all financial transactions and online commerce, not to mention the security of all personal data. Its consequences for the City do not bear thinking about."

Labour's manifesto pledged to "provide our security agencies with the resources and the powers they need to protect our country and keep us all safe." But added: "We will also ensure that such powers do not weaken our individual rights or civil liberties". The Liberal Democrats have vowed to "oppose Conservative attempts to undermine encryption."

But with a large Conservative majority inevitable, according to polls, ministers will be confident of winning parliamentary support for the plan. Only a rebellion led by Davis-esque liberals is likely to stop them.

George Eaton is political editor of the New Statesman.

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