Mark Carney performs a handbrake turn on interest rates and Forward Guidance

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“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.

Past History

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.

This entry was posted in Bank of England, General Economics, Interest rates, Quantitative Easing and Extraordinary Monetary Measures, UK Inflation Prospects and Issues, Uncategorized and tagged , , , . Bookmark the permalink.
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  • Doubting Dick

    Am I suffering conspiracy theory overload or could he be helping the ECB to reduce the relative value of the Euro? Whether intended or not, this has to be one of the end results.

  • Jim M.

    Hi Shaun,

    Hmm… from here in the cheap seats it seems that the principal role of Mr Carney and “his “mates” from international organisations” is to make FIFA appear to be a model of financial probity!

    That nice Mr Galbraith may have been on to something.

  • Robert S

    This Governor is a fool!

    Admittedly, what I know about economics from my amatuer, interest in economics, can be written on two postage stamps (single sided, of course), but let’s assume that I know nothing and I casually watched the late night news back in 2013; I hear that this spanking new Governor from a previous colony of ours says that he’s issuing forward guidance so that I have an idea when interest rates are going to rise. So I think to myself, do you know what ol’son, now might be a good idea to buy a house whilst the interest rates are low and are kept low for a short period of time. But low and behold, not quite one year later (I think Mr Maple Leaf arrived in June and issued guidance in July, but I could be wrong), I’m told that interest rates might go up in the near term! Now I know we only live for about 3 score and 10, but even I think that a “short” time should last more than 1, 1 and half years.

    What a fool. He swerves this way and that so much, that I think he could’ve replaced the late Mervyn “Swerve the Merv’” Davies in the Welsh rugby team!

    Great article, again, Shaun, thank you.

    Robert S

  • Foxy

    Inflation under control, wages growth subdued, spare capacity, strong pound, so why hint at base rate rise, sooner than later? Does he know something we don’t know? I wonder if Mervyn is busy?

  • Anonymous

    Carney can claim whatever he likes with GDP – significant parts are just made up.

    Business investments could be innovative technologies to smuggle drugs, for example a passing ship could drop a heavy watertight container. A local power boater can come by later with a remote signalling device instructing the deployment of an airbag etc, causing container to rise can be collected. (Source: some news report, reporting a breach). Columbian smugglers have used submarines to deliver cocaine.

    Adding illegal drugs to GDP allows a whole asylum of tricks to gerrymander GDP ever further from reality….

  • therrawbuzzin

    Keeping the right level of inflation of a bubble until the next election, must be a tricky business.

  • Pavlaki

    Whilst part of me wonders about the accuracy of official projections (which appear to be out of date as soon as they are issued) the other part is at least pleased that Carney is not too dogmatic and prepared to change his stance when the facts change. I am more concerned about the data he is being given on which decisions are to be made. Their forecasting ability appears to be woeful. I guess they are very worried about ‘taking away the punch bowl just as the party gets going’ and then finding there wasn’t party after all! In a reversal of the Eurozone situation, confidence appears to gave returned to the real economy whilst the financial governess lag behind.

    It would appear that finally the Euro can’t fly on forever without any wings and the engine removed by Draghi. It needs to drop much further though to really help the peripheral economies. I wonder – how low can it go?

  • Anonymous

    When does Carney’s term end? I’d imagine he just wants to help this baby limp on then get the hell out with his fake political points.

  • Pavlaki

    Damn predictive text! Read ‘ confidence appears to have returned to the real economy whilst the financial governance lags behind’.

  • Anonymous

    Thanks to your excellent column, Shaun, I looked up videos of
    Governor Carney’s Mansion House Speech and Frankie Valli and the Four Seasons singing “Oh What a Night”. The Frankie Valli video was immensely entertaining, Governor Carney’s, not so much.

    Your line about the Bank of England trying to live inside a mirror made me laugh. The explanation why the British public is being told to expect a bank rate rise would seem to have nothing to do with the inflation
    knockout, since the May Inflation Report said: “Inflation has been near to the target in recent months, and is expected to remain at, or a little below, 2% throughout the forecast period [that is, through the first quarter of 2017].” It would seem to be justified by the financial stability knockout. A housing bubble is inflating, and it seems that Governor Carney no longer has quite the same faith in the ability of macroprudential tools to solve all problems that he seemed to have when he started at the Bank of England. He never talks about knockouts at all in the speech. He is so busy invoking canoe trip metaphors, conforming to a Canadian stereotype, he seems to have forgotten his formerly cherished boxing metaphor.

    As you point out, a CPIH based on the net acquisitions approach
    to owner-occupied housing would probably show inflation above 2.5% now. I am not sure if a forecast 18-24 months out for the same indicator would still show such high inflation, but it might. Then raising the bank rate could be justified based on the inflation knockout. Andrew Baldwin

  • Noo 2 Economics

    and the Fed with the dollar, just as they cut back on money printing, putting upwards pressure on the dollar carney comes to their rescue as well as the ECB and the Bank Of Japan for that matter – just not sure how he’s helping with re balancing the UK economy and the trade deficit……

  • Noo 2 Economics

    Yes, his forward guidance has led him into an admission that he think’s he’s probably got it seriously wrong.

    One thing though, he has demonstrated a willingness to change his stance in the face of new information rather than doggedly sticking to old policies that are clearly wrong.

  • Eric

    Great stuff Shaun,

    You admirably highlight the great unanswered question. No; not life, the universe, and everything, but – What is monetary policy really targeting?

    What are they trying to hide with OMO and Forward Guidance. Not coming clean certainly makes the Govnr. look inconsistent and erratic; some might say foolish.

    Could it be that debt (household and Government) and still-too-big-too-fail banks with dangerous balance sheets have something to do with it? Which makes a target hard to explain in terms of the economic indicators and measurements – because they aren’t relevant to the real objective. Or am I way off?

    What do you think they are really targeting, Shaun?

  • Anonymous

    Hi Doubting Dick

    It is an interesting line of thought and Mark Carney’s complete change of direction does offer fertile ground for conspiracy theories! The UK Pound has been rallying against the Euro over the past year (~7%). The question is then though why the powers that be want to help the Euro and are getting other central banks to help?

  • Anonymous

    Hi Jim M

    Oh dear that is rather a low bar as FIFA usually jostles with the IOC on that front. As to Mr. Galbraith he would plainly have been a critic of Forward Guidance and would presumably be pointing out that the fact that it is Forward Guidance 3.0 in less than a year backs up his critique..

  • Anonymous

    Hi Foxy

    You are right to point out that Mark Carney’s change of mind is illogical considering the criteria he has set out. Indeed this poses the question of what criteria he has?! We may find that he picks whatever of the 18 measures the Bank of England now has as suits what he thinks at the time rather in the manner of a Magpie. That does not make for any sort of useful Forward Guidance does it?

  • Anonymous

    Hi ExpatInBG

    As with so many economic concepts that have withered somewhat when the full glaze of publicity gets on them I suspect that the same would happen to Investment. One (wo)man’s investment is another’s consumption..

    As to the submarine part I think I do recall the Royal Navy plugging the ASW capability of its Carribean guardship. Now would they be considered to be GDP deniers?

  • Anonymous

    Hi therrawbuzzin

    Yes nicely bubbling with no boiling over and especially not going flat…

  • Anonymous

    Hi Pavlaki

    Whilst I agree that it can be a strength to change your mind as many things are uncertain what the first year of Mark Carney’s Governorship indicates is a lack of a framework. Indeed what he has is contradictory because if the labour slack is still 1 to 1.5% of GDP then why has he changed his mind?

    The Euro has indeed nudged lower but as you say there is plenty more to do. Will the other currencies let it do it especially the Japanese Yen?

  • Anonymous

    Hi Progrock

    It is a five year term so four and a bit to go. There must have been some plan as it is different to the (unlucky) seven year terms of Mervyn King.

  • Anonymous

    Hi Andrew and thank you

    The situation regarding Bank of England policy has got very opaque. For example Thursday saw hints of measures on housing which were backed up but then Mark Carney assured us they were not part of his mandate!

    “To be clear, the Bank does not target asset price inflation in general or house prices in particular.”

    So Mark what are you targeting? Was he like this as Governor of the Bank of Canada?

    As to the song I used to work with someone who would sing it at every opportunity so it is etched in my memory.

  • Anonymous

    Hi Eric

    There is nothing wrong with your point about debt. As to what has been the real target well whether they have meant it or not perhaps nominal GDP growing at 5% per annum. So they could ignore higher inflation when growth flatlined and now worry with relatively benign inflation because growth looks strong.

  • Anonymous

    Thank you very much for your reply, Shaun. Yes, Carney was saying the same kind of silly things about asset prices when he was in Canada. The big difference then was he was targeting an inflation indicator, the Canadian CPI, that was similar to the RPI, and closely monitoring the Bank of Canada’s own core CPI, which, since it excludes mortgage interest, would resemble a core measure based on the RPIX when it was still the BoE’s target indicator. So he spent his whole public career in Canada working with inflation indicators that give a heavy weight to housing prices and dwelling prices, while denying that they are appropriate to an inflation measure.

    This acutely schizophrenic mindset he seems to have acquired from his mentor, the former governor of the Bank of Canada, David Dodge. Dodge wrote in a 2009 paper: “In setting the policy rate central banks should continue to focus on consumer prices over the
    medium term, not directly target asset prices.” Then, in a footnote, he allows that house prices are in the CPI anyway.

    Incredibly, Dodge seems to believe that these are the Royal LePage resale price indexes. All house price data, for both dwellings and houses, in the Canadian CPI, comes from StatCan’s new housing price index (NHPI), which are used even when it is obviously inappropriate to do so, as a price index for real estate commissions (i.e. the Canadian equivalent of estate agent fees).

    Carney had to be aware that house prices were included in both the Canadian CPI and the core CPI. I suspect he neither knew nor cared what price data was used to measure housing prices in those indicators, and quite likely shared his mentor’s misconception that the CPI used resale price indexes, not the NHPI. I don’t believe there was any time when he was governor that a Monetary Policy Report displayed NHPI data, rather than resale price index data.

    A nitpicker could argue that the Canadian CPI does not measure the price of houses as an asset, but only the consumption cost of depreciation on homes, for which a dwelling price index is used as the measure. (In a market where dwellings and lots were separately transacted, and growth in the dwelling stock was just keeping up with population growth, the difference between this approach and the net acquisitions approach would be minimal.) However, neither Dodge nor Carney has ever made this argument, and it is hard to see how Dodge, at least, would ever make it, given his misconceptions about how the Canadian CPI is calculated.

  • Anonymous

    Christ, I bet he feels that is interminable now.

  • therrawbuzzin

    He may be a fool, he may not.
    The problem, as I see it, is that he’s being dishonest about his motivations, and when that dishonesty rebounds on him, he looks a fool

  • Eric

    Ah! I see what you mean; but if growth is primarily supported by increasing debt rather than rising productivity and incomes then we could easily be right back where we started if asset prices fall. (Cue Maxine Nightingale!). That should be a cause for concern in Threadneedle Street thus the desire to keep rates “low for longer”.

  • David Lilley

    You have convinced me that there is no need to increase interest rates just now.
    But at the same time I must remember that your fellow poster, Simon Ward, estimates that there is little or no slack in the economy and that inflation will rise to 2.75% by autumn. November therefore does seem a likely time for a 0.25% rise in the base rate.
    The Mansion House speeches are our nearest to a “state of the nation” speech by the US president and therefore required viewing.
    The only thing that the media focused on was the posibility of an interest rate rise before the end of the year, as, sadly, their only focus is on house prices and “here we go again”.
    There has been little correlation between base rate and what we pay to borrow or what we receive as savers for many years.
    Far more interesting bits of information from this “state of the nation” were that the deficit will be halved this year, 2m extra private sector jobs have been created since 2010 and 75% have been full time and GDP will be 4% this year. These are great numbers but apparently of no interest to the media or, indeed, my target audience here.
    “The fastest growing economy of the advanced economies” cannot be repeated.
    I have my own doubts about these numbers but at least they are non-conspiritorial.
    -We hear that as many as 78% of new employment is self-employment and that might include selling four copies of the Big Issue. Only working tax credit makes the job pay. And we all know that 80% of start-up fail.
    -The 2m extra private sector jobs must be offset by the variously quoted 300k to 600k jobs lost in the public sector.
    -The 4% GDP will reflect the new way we measure GDP starting in September. I do agree with this new measure that was first introduced/muted in the US a year ago. If something adds to GDP it adds to GDP, even if it is black market.

  • David Lilley

    Robert S,
    3 score and ten.
    Socraties lived till 70. We add one year every four years. We will have 30,000 centurians by 2020. Japan will have 50,000. We had over 1m over the age of 85 some 10 years ago. A baby born today can expect to live till 100.
    Yet a recent post on this site had 63 years as the life expectancy in Scotland and a BBC post this week had 61 as the life expectancy in Glasgow and 60% of them never marry.
    Gordon Brown made the teleological case that Scots have major health and ageing population issues that they should stay in the union because the Sassenacs fund them.

  • Noo 2 Economics

    Thanks for adding balance David, as you know this blog is populated by people concentrating on the negative but provides balance to all the positive spins I read.

    The problem I have with black market GDP is that the method of measurement is literally suck your finger and hold it up in the air!!

    It’s bad enough that we have all these relentless GDP revisions demonstrating how “accurate” the currently official numbers are without adding in numbers that are pure guesswork and yes, I agree with Shaun that R & D numbers should not be added to GDP as they are already reflected in the end price of products.

    I think the Government/BOE is taking alternative approaches to base rate rises – Mortgage market review (MMR) and Help to buy (HTB) along with Funding for lending(FLR) which has been adjusted a couple of times along the way, not forgetting QE of course.

    I think we and Simon need to adjust to the new world where base rates are pretty meaningless, where authorities use old conventional (MMR is a rerun of some of those parts of the 1974 Consumer Credit Act that Thatcher repealed in the early 80′s)(QE) and a mix of new unconventional(HTB) (FLR) macroeconomic and monetary tools to heat up/cool down economies.

    Meanwhile, the markets will calculate the likely effects of such measures and adjust interest rate expectations via gilt and bond prices which is what really matters to mortgage holders, savers and investors.

  • Bones

    Hi Shaun,
    It seems like your Mr Carney is making it up as he goes along. A good strategy if he is in front of the curve. A bit of a bugger if he is behind it.
    Just a small point. The RBNZ has lifted the OCR three times this year by 0.25% each time.
    I have been impressed how your team has performed here in NZ over the last two weeks. I think they are going to be a real force in the RWC at home next year.

    P.S. Keep up the good work it is greatly appreciated.

  • therrawbuzzin

    Does anyone really believe that all Westminster parties are being so desperately dishonest in their “NO” campaign in order to hang onto a financial drain?
    Is anyone really that stupid?
    These people who pawned the country, and abdicated their political responsibilities to their electorate in order to save the rotten-to-the-core banks, want to keep Scotland whose population don’t EVER vote Tory, and who are supposedly a financial drag?

  • Anonymous

    Hi David

    The base rate position is a tight one for me right now. I have argued for base rate rises in the past due to higher inflation and would prefer one in the range 1.5% to 2%. However we are where we are (0.5%) and with the pound where it is touching US $1.70 earlier today then a base rate cut could make it overshoot. So this is a difficult time where the choice is tight say 55-45.

  • Anonymous

    Hi Bones

    I have thoroughly enjoyed the games so far and it has been good to see England play so well at what are the hardest grounds in the world to play. However some of the All Blacks play has been outstanding especially the early part of the second half this week and Ben Smith’s tackle on Tuilagi (as well as the rest of his play) shone on Saturday.That will reach us to put a centre on the wing! Actually changing our team weakened us as for example Farrell and Twelvetrees were outclassed by your midfield. However if I was Stuart Lancaster I would be really rallying the troops for the last game….

    As to the rate rises apologies, my attention must have been elsewhere when one of them happened.

  • David Lilley

    I completely agree with you but we have to be 100% yes. It is everyone’s best interest.
    They gave us two drinking partners who were two of the best thinkers posterity will ever know, David Hume (the greatest thinker) and Adam Smith (the first and still the greatest economist to date).
    Nevermind Gordon Brown’s revolting teleology. All teleology is revolting except when it is pragmatic.
    Independence may be good old Jacobien but it does mean that overnight Scotland becomes an international competitor and not a commonweath partner. Better to have a poor partner than a competitor.