“Oh what a night” sang Frankie Valli and the Four Seasons and I was reminded of that song last night. The date however had moved from December 1963 to June 2014 as Mark Carney gave an extraordinary Mansion House speech. Indeed it appeared that he has taken one of Margaret Thatcher’s phrases to heart “U-Turn if you want to” and indeed as a piece of policy advice. Here below was his opening salvo.
There’s already great speculation about the exact timing of the first rate hike and this decision is becoming more balanced.
This was already quite a change if we think that this is the man who has set his stall out on the importance of Forward Guidance of which more later but explicitly argues against such surprises. But there was more on the subject of Base Rate rises.
It could happen sooner than markets currently expect
So the R word as in rise in interest-rates was deployed and we got a reference to this issue in the speech’s conclusion in response to thoughts that macroprudential policy might delay a Base Rate rise.
However, macroprudential policy is not a substitute for monetary policy. If it is used for insurance it won’t necessarily affect the path of interest rate increases….. The start of that journey is coming nearer.
If we look back to when Mark Carney raised interest-rates at the Bank of Canada he made not dissimilar statements a couple of months before (h/t @MontyLaw). Also recent times have seen the Reserve Bank of New Zealand raise interest-rates twice including this week after first giving macroprudential policies a go.
Where does this leave Forward Guidance?
It is quite clear that the concept of Forward Guidance which is the child of Mark Carney’s term as Bank of England Governor is both in disarray and discredited now. After all we have already had a target which was abandoned (the 7% unemployment rate) and now as he mulls a possible Base Rate rise I was reminded of Mark Carney’s words from December 2013.
It reduces uncertainty by providing reassurance that monetary policy will not be tightened prematurely before the recovery is sufficiently entrenched to sustain higher rates. This helps give households and businesses the confidence to spend and invest.
I wonder if anybody heeded his words and how they feel now? Regular readers will be aware that I argued from the beginning of Forward Guidance that it was like an Emperor with no clothes and now it appears to mean that interest-rates can be lower,stay the same or rise! To use Mark Carney’s own words it was a sign that monetary policy was “maxxed-out” and that open mouth operations replaced actual ones.
What about inflation?
As we recall that policy is supposed to be set to achieve a 2% annual rise in the Consumer Price Index we have an issue in that it is at 1.8% as of May. Okay so Governor Carney must think that it is going to rise, except if we look at last month’s Inflation Report we were told this.
the outlook for inflation in the medium term remains benign…..
So unless the outlook has changed out of all recognition in the last month then the supposed target does not seem to be the driving force. An alternative view is that the Bank of England is also looking at the labour market and in particular wages as one of its guides. But again in the Inflation Report we were told this.
However, unit labour cost growth of only 1% is expected over 2014, and remains consistent with meeting the inflation target in the medium term.
There has been a change here but the other way! It was only on Wednesday I analysed the disaapointing official earning statistics for April where regular pay was only 0.4% higher than a year before. So we advance with inflation expected to be on target and wage growth turning out to be disappointingly weak and accordingly these were unlikely to have changed Mark Carney’s mind.
The supersoaraway UK Pound
This has been a strong disinflationary influence on the UK economy since its recent low in March 2013 and indeed there was a nod to this in Mark Carney’s speech last night.
a 10% appreciation of sterling over the past year or so,
Well he can now add to that last night’s rally in the value of the pound as it blasted past US $1.69 and Euro 1.25. If you apply the rule of thumb for the expected impact of this which the Bank of England has “forgotten” then it is equivalent to a 2.5% rise in UK Base Rates.
Accordingly we find ourselves reviewing an extremely odd situation alomost as if rather than looking into a mirror the Bank of England is trying to live inside one. When the pound was weak and inflation surged to more than double its target then we told we could not have Base Rate rises. But now inflation looks more benign, wage pressures are suprisingly weak and the pound is strong we now are supposed to be ready for a Base Rate rise! So much for inflation targeting….
A bi-polar approach
Actually the speech last night had some more familiar themes which also suggested that an interest-rate rise was not at the forefront of the Governor’s mind. Look at the output gap.
Internally, there is wasteful spare capacity – an output gap – concentrated in the labour market. The Monetary Policy Committee (MPC) currently estimates this gap to be around 1-1½% of GDP,
However fast ou economy grows this never seems to shrink! It is like it is a permanent feature of the UK economy. So if we apply the stated logic of Mark Carney then interest-rate rises should be off the agenda for now. Indeed why say something once when you can say it twice?!
there remains scope for spare capacity to be used up before policy is tightened
If we recall this week’s wages numbers and the Bank of England’s own inflation expectations then this phrase is significant too.
The ultimate decision will be data-driven
Has Mark Carney lost his balance?
Back last December Mark Carney played down this issue of imbalances in the UK economy but perhaps he had been reading up on it and doing some research before last night’s speech.
The UK economy is currently unbalanced internally and externally.
Okay good to see he is getting better informed but then a page later maybe he is not so sure?
Amidst much commentary about an unbalanced recovery, it should not be forgotten that business investment has accounted for more than a quarter of GDP growth over the past six months.
Actually the issue of balance comes up a lot in this speech, has he taken up Yoga or Tai Chi? Actually with the stresses of being a Bank of England Governor that might be his sharpest move yet. We get another type of balance report here.
The UK’s current account deficit is at a record level.
Perhaps Mark will explain how giving a speech which has lit up a fire below the already strong pound will help with that. One thing we do know is that it makes the Base Rate rise simultaneously more difficult and less necessary which fits with my “dark side” theory of UK monetary policy
The quote below was more revealing than Mark Carney intended I think.
To be clear, the Bank does not target asset price inflation in general or house prices in particular.
It poses the question exactly what are they targeting? To which we get a rather vacuous response these days especially if we consider that last nights hint of a Base Rate rise comes at a time when the claimed targets are relatively benign. Personally I think that it should be something the Bank of England targets and if we put house prices into the official CPI we get by my maths a CPIH of 2.7%/2.8% or over target an environment where a policy response would surprise almost no-one.
If we consider the prospects for a change in UK monetary policy now after this speech then in football terms we now seem something of a 2-2 draw. I also note that the Governor is showing signs of being inconsistent and somewhat erratic. This is a troubling development for UK monetary policy especially as he will soon be joined on the MPC by two of his “mates” from international organisations. Central banks are supposed to be a stabilising force But last night was a failure for Forward Guidance as well as central planning and has added to instability instead.