Whenever interest rates eventually rise from their current historically low levels – you’ll have heard it first from the Bank of England.
Mark Carney was the right appointment as Governor of the Bank of England. He is hugely talented and it is good that the UK went for the best person for the job. But the whole forward guidance story has a few people scratching their heads
In the past year, statements from the Bank seem to have covered every eventuality. In the first phase of “forward guidance” introduced by the Bank, interest rates were not even going to be considered for a rise until unemployment dipped below 7% which the Bank forecast would not happen until 2016.
However the Bank misread the recovery and in particular the labour market and unemployment dropped more quickly than they expected.
The Bank still made clear they would not raise the base rate yet and markets expected it to go up in 2015.
Concerned that markets still underestimated the potential for a rise in the base rate before 2015, the Bank pointed out in its latest MPC minutes that “market participants put only a 15% chance on a rise in Bank Rate by the end of 2014”.
The Governor built on this in his Mansion House Speech earlier this month saying:
“There’s already great speculation about the exact timing of the first rate hike and this decision is becoming more balanced. It could happen sooner than markets expect.”
This was widely interpreted as a warning to markets that a rate rise would come this year rather than next. Sterling moved up against the dollar and Euro as markets expected an early rate rise.
But did the markets misunderstand the Governor?
After all, he went on to say in the very next paragraph of his Mansion House speech, “to be clear, the MPC has no pre-set course. The ultimate decision will be data-driven. At this point it is safest to conclude, as the MPC has, that there remains scope for spare capacity to be used up before policy is tightened and that a host of labour market, capacity utilisation and pricing indicators should be watched closely to determine how that slack is evolving.”
So, maybe a rise early, and maybe not.
And then this morning, giving evidence to the Treasury Select Committee, the Governor said, “We have not yet seen incomes really growing, we expect that to happen and it will be consistent with a durable expansion."
"The exact timing of that [increases in interest rates] will be driven by the data."
Finally he and other MPC members who gave evidence said the whole point about guidance was not to predict when rates might rise but that when they did the future path would be “limited and gradual”.
So how much does all of this matter?
It is only fair to point out that the Bank of England was not alone in underestimating the speed and strength of the UK’s economic recovery. Others have revised their forecasts too. But if that is the case, and policy must adapt as the reality changes, then perhaps it is best not to make so much of forward guidance in the first place.
The whole point of forward guidance from a central bank is to give clarity of expectations to consumers and businesses. If the guidance keeps changing, that clarity is either damaged or lost.
This speaks to a wider question in modern economic policy. With Governments keen to say they run fiscal policy and central banks run monetary policy, perhaps too much weight is being placed on the powers and influence of those central banks. Is it time for central banks to be more realistic about what they can and cannot do?