12 Sep 2013

It’s a knockout – MPs grapple with new interest rate guidance

If MPs were hoping to get clarity on Mark Carney’s “forward guidance” on interest rates today, it seems the two-hour long interrogation didn’t deliver. Most appeared to be left scratching their heads.

Andrew Tyrie, the Treasury Select Committee Chairman -somewhat sarcastically – summed it up like this: “Credibility in monetary policy is hard won and easily lost.

“The new framework – with its target, threshold and three ‘knockouts’ – is more complex to explain than its predecessor. Rightly, the Bank is now engaged in bolstering credibility in its new framework with detailed explanations.

“Confidence in monetary policy will be enhanced where those detailed explanations provide greater certainty about the likely responses of the Bank as circumstances change.”
The Governor of the Bank of England Mark Carney speaks to parliament's Treasury Committee, in Westminster, London

Note what Mr Tyrie does NOT go on to say – as you might expect – is that Mr Carney provided that greater certainty today. Reading between the lines, the view was that he did not.

If anything, this was the first time we saw the self-assured Canadian somewhat rattled, as MPs came at the same issue time after time, trying to understand exactly what and when would trigger the Bank of England to raise interest rates.

The Monetary Policy Committee has said it will only start thinking of raising rates from their current 0.5 per cent when the unemployment rate falls below 7 per cent, which it doesn’t foresee happening until 2016.

MPs unconvinced

Mr Carney reiterated that over and over again today. But MPs didn’t seem convinced.

They continued to grill him over how the guidance – which is subject to three financial knockouts or caveats – might work in practice.

In so doing, some MPs got targets confused with thresholds, among other errors, much to Mr Carney’s visible aggravation. It’s very important people understand this, he reassured. I want to make it absolutely clear, he insisted.

But there was a definite sense some of it was through gritted teeth.

“My experience in talking to businesses, our experience in terms of surveys of household expectations, has been that the message [of forward guidance] has been understood,” he told MPs.

He’s right in one way. What’s been understood by most people on the street is that interest rates won’t be raised until at least 2016, so in the interim they’re free to spend, spend, spend.

But as Mr Tyrie pointed out,will Joe Bloggs really be monitoring the “knockout” conditions on a daily basis? Probably not.

It’s a knockout!
If any of the three so-called “knockouts” listed below are breached, the Bank’s future guidance on interest rates would no longer hold. MPs argue this could all be too complicated for the average Joe to understand. And that the message the Bank has really made clear is that it wants more spending and less saving.
• in the MPC’s view, it is more likely than not, that CPI inflation 18 to 24 months ahead will be 0.5 percentage points or more above the 2% target;
• medium-term inflation expectations no longer remain sufficiently well anchored;
• the Financial Policy Committee (FPC) judges that the stance of monetary policy poses a significant threat to financial stability that cannot be contained by the substantial range of mitigating policy actions available to the FPC, the Financial Conduct Authority and the Prudential Regulation Authority in a way consistent with their objectives.
Confused? You could be.

So in that sense, doesn’t the Bank’s guidance around interest rates really amount to a loosening of policy – in other words, another interest rate cut in disguise?

“Not so,” insisted Mr Carney, although he was forced to concede this: “We expected this (forward guidance) to provide greater stimulus by providing greater transparency,” he said. Isn’t stimulus just another word for loosening?

The market isn’t convinced by Mr Carney either and is factoring in a rate rise as early as 2015.

The pound rose again today off the back of his comments, as investors continued to doubt Mr Carney’s arguments. That follows a rise in a pound yesterday too, as employment numbers came in better than expected.

And the Governor was none too reasurring about the housing market either, saying the bank needed to be “vigilant” about ever-rising prices.

Mr Carney stressed that activity levels in the housing market were still about two thirds to three quarters below pre-crisis levels. But he conceded: “There has been an improvement, and perhaps some acceleration, so we do need to be vigilant about this without question.”

He said the bank stood ready to increase its supervision of the lending market if there were signs of overheating and in some instances could actually force banks to hold more capital as a safety cushion against mortgages turning bad.

And nor did Mr Carney rush to back the Chancellor’s comments, this week, that the UK economy has turned a corner.

“I’m hesistant to get pulled into a potential debate for obvious reasons,” he said, adding. “It’s certainly positive the economy has stopped shrinking. It was stagnating, it’s now picked up…..It’s welcome. But it is early days in that recovery and it is a long way to get back to the potential of this economy.”

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