The last week has seen a change in UK monetary policy as it was a week ago that the new Governor of the Bank of England Mark Carney formally announced his plans for “forward guidance” for the official short-term interest rate (base rate).
In particular, the MPC intends not to raise Bank Rate from its current level of 0.5% at least until the Labour Force Survey headline measure of the unemployment rate has fallen to a threshold of 7%, subject to the conditions below.
There were also three potential “knock-outs” for this policy but on analysis they proved to be more of a weak jab than a powerful left hook. For example the inflation knockout depended on the inflation forecast of the Monetary Policy Committee being over 2.5% two years ahead. As it did not manage such a forecast even when inflation went above 5% that seems a high hurdle. The inflation expectations one can be similarly dealt with as they have in fact been over the inflation target for some time in the Bank of England’s own survey! If you think about it the Financial Policy Committee’s whole purpose right now is probably to avoid interest-rate rises (for banks anyway) so the “knock-outs” will only ever apply should it suit the Monetary Policy Committee. So for all the hype we find a situation where a group of people who were against a rise in interest-rates have simply declared that. Or what has been labelled “open-mouth operations”.
Interest-Rates are in fact rising
Whilst the Bank of England can and is keeping the base rate at 0.5% this is only for short-term money and there are a lot of other interest-rates in the economy which are at least as important. If we look at interest-rate futures we find that in the week since formal forward guidance began we have seen price falls and hence increases in implied interest-rates. Last Thursday I discussed the movements as follows.
If we look at the contract for June 2016 which had closed at 98.42 the day before those who thought that they had the “early wire” pushed it up to 98.56 before the announcement but afterwards it plunged to 98.24.
So a pre-announcement rally followed by a sharp drop. As I am typing this the latest price is 98.18 so the response to guidance which you might think would push expected interest-rates lower has been for them to in fact go higher. In the summer of 2016 they are implying 1.82% and this rate has risen by a quarter point since the announcement.
UK borrowing costs
This is on my mind partly because the UK will commit itself to borrowing some £2.25 billion for just over twenty years (2034) tomorrow. Unfortunately that comes as UK Gilt (government bond) yields have surged to an eighteen month high. Last night the ten-year Gilt yield closed at 2.6% and this morning it has pushed higher to 2.63%. So not only have Gilt yields risen and not fallen in response to forward guidance but starting tomorrow there will be an explicit cost for the UK taxpayer.
Hopefully those who are planning to vest their pension and take out an annuity will at least see some benefit from this as the 30 year Gilt yield has risen to 3.67%.
Monetary Policy Minutes
The release of the August meeting minutes has told us that there was no a complete consensus on the new policy.
One member of the Committee (Martin Weale), while supportive of the adoption of forward guidance, voted against the proposition in order to register his preference for a time horizon for the first inflation knockout that was shorter than proposed.
But there was something extremely familiar.
The Committee’s best collective judgement was that by the second half of the forecast period the risks around the 2% inflation target were broadly balanced.
Also in a round-about way we got a confession of past mistakes.
The Committee’s remit provided it with flexibility to attenuate the speed at which it brought inflation back to target
So far that has taken 44 months and counting. Oh and sometimes I think they like to liven up the document with a bit of humour.
The Committee agreed that it was of paramount importance for the credibility of the monetary policy framework that its commitment to meeting the 2% inflation target in the medium term was beyond doubt. It was critical that the design of the guidance strategy did not put this credibility at risk.
What about the UK economy?
The MPC linked in the performance of the UK economy with its forward guidance on interest-rates.
The statement issued after the Committee’s July meeting had indicated that, in the Committee’s view, the large upward move in market interest rates in May and June had not been warranted by developments in the economy
It then indulges in a bit of back-slapping about what happened next which of course reads poorly now as this reversed, as discussed above. So potentially open-ended forward guidance is struggling after just over a month. Much more Clark Kent than Superman. Also in a nice coincidence of timing I note this.
Moreover, the unemployment data were relatively reliable, less prone to revision and well understood.
The UK Labour Market
The Office for National Statistics has issued a positive report this morning.
The employment rate for those aged from 16 to 64 for April to June 2013 was 71.5%, up 0.1 percentage points from January to March 2013
Between April to June 2012 and April to June 2013 total pay rose by 2.1% and regular pay rose by 1.1%
So employment was higher and total pay rose at a faster rate than in the previous period. Let us now examine the new target which is unemployment.
The unemployment rate was 7.8% of the economically active population, unchanged from January to March 2013 but down 0.2 percentage points from a year earlier. There were 2.51 million unemployed people, down 4,000 from January to March 2013 and down 49,000 from a year earlier.
So compared to the Bank of England’s own expectations in its Inflation Report published last week of a 7.9% unemployment rate there has been an improvement. Indeed the economist Danny Blanchflower was arguing that the rate would rise to 8% based on his analysis of the UK economy.
We can indeed look deeper into these numbers as there are ones released for June alone.
UK unemployment rates 16+ (seasonally adjusted): The single month estimate for June 2013 shows a decrease of 0.6 percentage points from the previous month.
UK employment rates 16-64 (seasonally adjusted) The single month estimate for June 2013 shows a increase of 0.8 percentage points from the previous month.
As you can see these are very strong figures. On this basis the UK unemployment rate is now 7.4% (apologies for typing 7.5% in the original draft) and getting rather near to the 7% threshold! So forward guidance might soon be over….
One of the dangers of taking a centrally planned approach to economic management is that you are prone to looking leaden footed as events develop and change. This is what is currently happening to the new Bank of England Governor Mark Carney. His policy prescription of “forward guidance” was intended to set out his stall for some time and yet the latest economic growth and unemployment numbers suggest that he has applied it at the wrong time. Even worse he has told UK financial markets that they were wrong about interest-rates when it was him that was in error.
Actually whilst we are in a good sequence of economic statistics I have my doubts still about a variety of issues. Just sticking to the labour market there is the issue of underemployment and the fact that real wages are still falling albeit more slowly. But Mark Carney may soon be reviewing this statement by John Maynard Keynes.
When the facts change, I change my mind. What do you do, sir?
The market response to the better data has been to tighten UK monetary policy via a higher level for the pound’s exchange rate and higher future interest-rates. Seems to be a better fit for events than official policy to me.