Bank of England governor Mark Carney last week ushered in forward guidance at the central bank, linking future base rate moves to the country’s unemployment rate.
Presenting the latest Inflation Report, Carney introduced a policy of “explicit state contingent guidance” and said the monetary policy committee will not consider lifting the base rate from its historic low of 0.5 per cent until unemployment below 7 per cent – subject to a number of get out clauses.
He also said quantitative easing will not be unwound from its current £375bn while unemployment stays above this level and suggested the MPC would look at adding to its asset purchase programme if the unemployment rate does not come down.
According to the Office for National Statistics, the UK’s unemployment rate is currently 7.8 per cent. The Bank expects median unemployment to stand at 7.3 per cent over the next three years, meaning the base rate is likely to remain low throughout the forecast period.
However, the governor detailed a number of ‘knock-outs’ that would allow the MPC to lift rates even if unemployment remained above the desired level. These include the outlook for inflation on an 18-24 month time horizon being judged more likely than not to be higher than 2.5 per cent and the emergence of threats to financial stability.
Carney said: “It is important to be clear that bank rate will not automatically be increased when the unemployment threshold is reached. Nor is 7 per cent a target for unemployment. So 7 per cent is merely a ‘way station’ at which the MPC will reassess the state of the economy, the progress of the economic recovery, and, in that context, the appropriate stance of monetary policy.”
The BoE joins a number of other central banks in using forward guidance to reassure about the future direction of monetary policy. The Bank of Japan used the tool in 1999 and the US Federal Reserve in 2012, while Carney brought it in at the Bank of Canada in 2009 when he was governor.
The move was welcomed by Chancellor George Osborne, who wrote in a letter to Carney: ”Given the exceptional economic challenges continuing to face the UK economy, I agree with you that forward guidance can play a useful role in enhancing the effectiveness of monetary policy and thereby supporting the recovery.
“I take note of the comprehensive arguments the MPC has set out for the choice of an unemployment threshold. I also note the committee’s important approach of allowing the threshold to be ‘knocked out’ if there are material risks to price stability or financial stability.”
Fidelity investment director Tom Stevenson, on the other hand, notes that the FTSE 100 dropped following Carney’s announcement as the inclusion of the knock-outs creates uncertainty around the direction of monetary policy.
“In other words, it’s forward guidance with some pretty big ifs. And to an extent that undermines the whole point of the exercise, which is to create certainty. There are still plenty of unknowns,” he says.
What impact will Carney’s move have on your clients?
The adviser’s view: Yellowtail Financial Planning managing director Dennis Hall
I think it makes our job that bit harder. A rate rise, which would help savers, is even further away.
When you add that to the Help to Buy scheme and other support offered by the Government to the housing market it does not look like there will be any competition to get savers money any time soon. With regard to equities we have seen how volatile things have been, and moves to reduce Quantitative Easing, or talk of rising interest rates ‘spooks’ the markets. It is not absolute forward guidance and there are caveats, so the volatility is likely to continue. There has been a big switch, the great rotation, from bonds to equities and those that switched away from bonds in the past year or so may have done so too soon.
Bond manager’s view: M&G fund manager Ben Lord:
I don’t think we actually got pure forward guidance, but a pretty muddled variant thereof. Bond markets are rightly unsure as to how to react, and have struggled for a satisfying interpretation. All we can really take from the BoE is that they will need to be sufficiently satisfied that the UK economy has reached escape velocity before hiking rates or reversing policy.
CIO’s view: Rathbones chief investment officer Julian Chillingworth
The striking thing about Carney’s statement is the degree of rope that has been afforded to him in terms of a time frame. This is a statement of ‘ifs’ and ‘buts’, but the threat of higher inflation still looms. The statement has undoubtedly been helpful for Chancellor George Osborne’s aim of boosting the feel-good factor and might encourage a mini housing bubble. But there is a distinct balancing act here between preserving the wealth effect and curbing the perception that the economy is growing too fast, thus risking higher rate expectations.
Mortgage broker’s view: John Charcol senior technical manager Ray Boulger:
The mere fact gilt yields did not move much after the announcement shows these markets were not too spooked by this and we are unlikely to see much re-pricing. What this does do is give borrowers a bit of breathing space in terms of switching rates. Rates are now likely to remain low for longer but borrowers should still consider some of the decent fixed rate deals available. While it makes sense to switch earlier in most cases, it allows those with a smaller deposit to build up a bigger deposit in order to qualify for a cheaper rate, as there is more certainty around when base rate will rise.”