The “Carney bubble” pops

The BoE´s eagerly awaited Inflation Report was a big letdown. The impact was even contractionary!

Reuters has a good summary:

“The threshold target for unemployment was higher than the market was expecting and the market’s perception was that if the economy recovers then rates might rise sooner,” said Paul Robson, currency strategist at RBS, after sterling was propelled to a one-and-a-half-month high.

Inflation is forecast to average 2.9 percent in the last three months of this year – close to its current level and a lower peak than previously thought – and then to fall roughly as predicted three months ago, hitting the two percent target in mid-2015.

Chancellor George Osborne, who wants “monetary activism” to offset his fiscal austerity push, welcomed the plan and said it was consistent with the government’s “absolute commitment” to Britain’s 2 percent inflation target.

There´s one silver lining. For that we have to go back to Carney´s speech on “Guidance” in December 2012. At the time he said:

From our perspective, thresholds exhaust the guidance options available to a central bank operating under flexible inflation targeting.

If yet further stimulus were required, the policy framework itself would likely have to be changed. For example, adopting a nominal GDP (NGDP)-level target could in many respects be more powerful than employing thresholds under flexible inflation targeting. This is because doing so would add “history dependence” to monetary policy. Under NGDP targeting, bygones are not bygones and the central bank is compelled to make up for past misses on the path of nominal GDP.

And further stimulus will certainly be required.

The charts illustrate the UK situation. It´s ‘unique’ in the relation between the NGDP gap and inflation. I examined that disconnect 2 ½ years ago in “What´s going on?” (on the inflation front)” In short, “Inflation Targeting” should be scrapped.