We are only six months into the Bank of England’s new regime of giving forward guidance about what circumstances might lead them to adjust the Base Rate and they are already in a bit of a mess with it. Whether forward guidance is abandoned or not is still in the balance, amid much confusion. However, much of this confusion seems to be due to the challenge that events have provided to the assumption that the Bank of England could make reasonably accurate economic predictions.

It turns out that not only did the Bank not know how fast unemployment would fall (not a surprise: the Monetary Policy Committee (MPC) minutes from August make clear that they suspected this might be the case), but neither did they know, when it did fall, what a 7% unemployed economy would look like. The Bank has been very surprised by how fragile it still is.

Back in August 2013, when unemployment was still at 7.7%, the MPC voted to embrace the forward guidance which has now fallen on its face. This said that: In particular, the MPC intends not to raise Bank Rate from its current level of 0.5% at least until the Labour Force Survey headline measure of the unemployment rate has fallen to a threshold of 7%, subject to the conditions below.

The “conditions below” were that all bets would be off if any of three “knockouts” were breached:

1. that it would be more likely than not that CPI 18 to 24 months ahead would be at 2.5% or above (in fact it has just fallen to 2%);

2. medium-term inflation expectations no longer remained “sufficiently well anchored” (the gently sloping graph below would suggest it hasn’t slipped that anchor yet); or

3. the Financial Policy Committee (FPC) judged monetary policy posed “a significant threat to financial stability”. More difficult to give an opinion on that one but, looking beyond the incipient housing market bubble, it is difficult to see that monetary policy is causing any other instability currently. Certainly not compared to the instability which would be caused by jacking up interest rates and sending mortgage defaults through the roof.

Source: Bank of England implied spot inflation curve

So it seems that there has been no clear knock out on any of these three counts, but that the “threshold” (it was never a target after all) of 7% is no longer seen as significant a sign of economic recovery as it had been believed it would only last August.

Fun as it is to watch the illusion of mastery of the economy by the very serious people flounder yet again, as what is an intrinsically good piece of economic news is turned into a fiasco of indecision, I think the Bank is right to believe that it is far too early to raise interest rates. I say so because of two further graphs from the Office of National Statistics (ONS) latest labour market statistics, which were not included in their infographic on the left.

The first is the graph of regional unemployment, which shows very clearly that large areas of the UK are still nowhere near the magic 7% threshold: the variations are so wide and, in austerian times, the resources to address them are so limited that it makes sense not to be overly dazzled by the overall UK number.

The second is the graph of those not looking or not available for work in the 16-64 age group since the 1970s. As you can see, it has recently shown a very different pattern to that of the unemployment graph. In the past (and borne out by the data from 1973 to around 1993) the number not available to work has tended to mirror the unemployment rate as people who could manage without work withdrew from the job market when times got tough and came back in when things picked up. However in the early 90s something new started to happen: people withdrawing from the job market even when unemployment was falling. There has been a steady increase in their number until it finally started to fall only last year. So what is happening?

One of the factors has been a big increase in the number of people registered as self employed, rising from 4.2 million in 1999 to 5.1 million in 2011. However, many of these people are earning very little and I suspect that at least some of them would have been categorised as unemployed in previous decades. There must therefore be some doubt about whether 7% unemployed means what it used to mean.

The Bank of England have shown with their difficulties over forward guidance that it is very hard to look forward with any degree of precision. It should be applauded for admitting that it doesn’t know enough at the moment to start pushing up interest rates.