In the depths of the 2008 financial crisis, central banks, particularly the Bank of England and the Fed, set thresholds on unemployment levels that must be reached before their expansionary policies are relaxed and the interest rate could rise. These thresholds are common and serve as goals for recovering economies to reach before supporting monetary policies are pulled. This helps to guide investors long run expectations by guaranteeing them certain central bank policies up to this threshold. The hope is that once the threshold is reached, the economy will be humming again and the low long term interest rates will have returned Investment to pre-recession levels.
Unfortunately, the thresholds set by the Bank of England (BoE) and the Fed, that were not expected to be reached for many months,seem to be fast approaching. With unemployment in the UK falling to 7.1 %, just a hair off from the 7% threshold at which they declared they would consider increasing interest rates, the Bank of England has been confronted with the decision of whether or not they should continue these expansionary policies. Some argue that the expansionary policies should be reeled in, driven by concern that such a large scale increase in the Money Supply could cause inflation to spiral out of control. Yet, while the unemployment rate has fallen to target levels, many show concern that this unemployment rate has been artificially deflated by workers dropping out of the labor force, reducing unemployment, and not by increased employment levels. If this is the case, pulling monetary support too soon could be devastating to the economies fragile and sputtering recovery.
However, whatever the BoE decides must be decided quickly. A lack of definitive direction by the central bank is introducing uncertainty into markets that is likely to increase expected long term interest rates and harm investment. Is the time right for the BoE to reduce its aggressive expansionary policies or should they continue to nurse the economy until it is abundantly clear that a strong recovery is underway? Whatever they decide could have significant implications at the Fed as Chairman Yellen will soon face a similar dilemma.