The new era of forward guidance has arrived
Whatever you think about the pros and cons of “forward guidance”, you can’t really deny that this is a landmark moment in UK monetary policy.
Ever since the Bank was granted independence to set interest rates back in 1997, there has been a guiding principle: that the members of the Monetary Policy Committee would never pre-commit to any future interest rate moves. When pressed, the former Governor, Sir Mervyn King, would always insist that he would decide a given month’s monetary policy only in that month itself.
As of today, the Bank is explicitly committing to future interest rates. To be more specific, it will leave rates where they are – at 0.5% – for as long as the unemployment rate is above 7%. Given that the Bank expects it to take until late 2016 for that to happen (the jobless rate is currently stuck at 7.8%), you can reasonably expect rates to remain where they are for some time yet.
Now, in some senses, this isn’t necessarily a departure from where we were yesterday. Interest rates are still in the same place; there has been no more quantitative easing (oh, and the above applies to QE as well as interest rates). However, Mark Carney is gambling on this new openness and clarity being enough to help boost confidence throughout the economy. The rationale is that if consumers are confident that borrowing costs are staying low not merely for a month but for a long, long time, they might be more willing to invest and spend.
The problem is that markets are still unconvinced. This morning, investors were expecting the first hike in interest rates to come in 2015. Mark Carney has now said explicitly that provided the Bank’s employment forecasts are indeed right, rates will stay on hold until mid to late 2016. However, in the wake of his press conference appearance, investors actually moved their bets on when rates will increase forwards, not backwards, to 2014.
The upshot is that either they expect unemployment to come down far faster than the Bank or – more worryingly as far as Carney is concerned – they suspect that the Bank is less united in their conviction than Carney. After all, the Governor is only one of nine people on the committee; it’s not infeasible that he could be outvoted on this policy in subsequent meetings.
Nonetheless, today’s move will make a real difference – not least among Bank-watchers. The inflation target remains in place – in theory – but in practice it has become significantly less important. Indeed, it represents only one of the three “knockouts” that would force the Bank to reconsider its pre-commitment – and even then the key rate is not the 2% which hitherto constituted the target, but 2.5%, 18-24 months into the future.
And, from a stats-watching point of view, unemployment rates suddenly become a lot more important. Which raises questions over whether they are really the best measure of how well the economy is doing. As I mentioned in my previous blog, there are valid questions over the ONS numbers on jobs – not least the fact that they are less timely than almost any other major economy.
All the same, the Bank is expecting today’s move to have a big bang. If its calculations are right, it should help spark lending to households and businesses in a meaningful way for the first time since 2009. And low rates underline the likelihood that the housing market will continue to recover. In short, the consumer is likely to contribute a lot of the economic impetus in the coming months and years – good news for George Osborne, who would love a little bit of the feedgood factor to return ahead of the 2015 elections; bad news for anyone hoping that Britain will soon rebalance its economy.
Finally, this policy obviously means yet more bad news for savers. By the end of 2016 interest rates will have been on hold for a full seven years. That’s the longest period of frozen rates since the aftermath of the Great Depression, when rates were on hold from 1932 to 1950; the difference being that then rates were at 2% – a full percentage point and a half higher than they are now.
Low or negative real interest rates have one obvious consequence: to transfer wealth from savers or creditors to borrowers. Now, that may well be a good and sensible long-term economic policy, but it is one with enormous social consequences. And that is the final point worth dwelling on: however much Mark Carney insists that this is a pure economic move, taken with complete independence, he is going to be walking an extremely tricky tightrope in the coming years as the impact of these policies play out among British households.