Let’s get this straight: Today the Bank of England did nothing to interest rates. It did nothing to quantitative easing; it even went so far as telling us that it would continue doing nothing a long, long way into the future.
And yet this all this doing-nothing amounted to the most radical shift in UK monetary policy for years.
Welcome to the bizarre world of post-crisis monetary policy.
Because what happened today was more significant than any small change in rates or QE: it represents a seminal shift in the way the Bank of England (and, for that matter, the European Central Bank) control the economy. Hitherto, these institutions have refused outright to give any hint of where rates are likely to go in the future. When asked by impertinent journalists, Sir Mervyn King and Mario Draghi would tend to say something like: “we never pre-commit to future decisions” or “we decide a month at a time – not in advance”.
Today, both the Bank of England and, a few hours later, the ECB, committed to holding interest rates low for an extended period. In the ECB’s case this meant a vague commitment along those lines. In the Bank of England’s case, it meant a statement released alongside the no-change decision saying “in the Committee’s view, the implied rise in the expected future path of Bank Rate was not warranted by the recent developments in the domestic economy.”
To translate, up until recently investors were expecting the Bank to leave interest rates on hold at 0.5% all the way until the end of 2016. The Bank was quite comfortable with this. But recently, on the back of speculation about the US Federal Reserve tightening policy, this changed. By last night, investors were pricing in the first increase in rates by late 2015. The Bank’s statement today is a direct refutation of this – and this chart is the one that prompted them to make this intervention:
It’s not formal forward guidance, such as we may well get when Carney has hammered out the new remit with the Chancellor next month, but it is guidance nonetheless – and a big shift.
So it’s not surprising that markets immediately reacted to the news: the cost of government bonds jumped (as investors speculated that the Bank won’t be selling off its QE stash of bonds anytime soon – in fact, may well buy more of them); the pound fell sharply against the dollar (looser monetary policy means less return from sterling-based investments).
Markets, in other words, are mulling the fact that the Bank is likely to be more open in the future about its plans. And this matters: after all, long-term interest rates – the ones against which mortgages and loans are priced – are determined as much by those market expectations as by the Bank rate itself.
So does this shift, which we’ve seen the first move in today, represent a sea change? Not really.
There is nothing new about central banks attempting to condition market expectations of its future rate decisions. The notion that the only tools they have at their disposal are rates or QE is misguided: for years the Bank of England has used the Inflation Report to give subtle guidance as to its future policy decisions. Its policymakers used carefully-worded speeches to signal where they were heading. Sir Mervyn King used to call this the “Maradona effect”: in that World Cup ’86 goal where he dribbled through almost the entire England team before slotting the ball beyond Peter Shilton, he actually followed a relatively straight line, but the “defenders reacted to what they expected Maradona to do”.
Forward guidance, in other words pre-committing to a certain level of interest rates for a certain amount of time, or until a certain condition has been met, is a logical extension of this – a less cryptic method, but with essentially the same aim. Nor is forward guidance itself a new idea: back in 2002, in his famous “helicopter money” speech, Ben Bernanke posited that central banks could “commit to holding the overnight rate at zero for some specified period”.
However, it’s only now that such ideas are becoming formal policy. Next month Mark Carney will issue his official response to the Chancellor on whether he wants to implement forward guidance in the UK, but today’s statement suggests he has already made up his mind.