My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.
It is early days but the Carney effect is already discernible at the Bank. Mark Carney, the new governor, took over three weeks ago today and has made a difference. The question is what else is in his box of tricks.
The first difference was the release of of a statement, after the first meeting of the monetary policy committee he chaired, on July 3-4, to hose down market interest rate expectations.
The markets had begun to discount a rise in Bank rate in less than two years’ time, in contrast to the position weeks earlier, when no hike was seen before late 2016. Nudged by its new governor, the MPC said this change of view was unwarranted.
The second change, which occurred at that same meeting but was not revealed until the publication of the minutes last week, was that the MPC, which had been split on the issue of quantitative easing since November, voted unanimously for unchanged policy this month.
Last month three of its number, David Miles, a long term enthusiast for QE; Paul Fisher and Sir Mervyn King, the former governor, wanted more asset purchases. This time, with King enjoying his retirement, the other two withdrew their call for more QE.
The new governor brought harmony where there was discord, to paraphrase Margaret Thatcher’s famous St. Francis of Assisi quote. His first meeting saw a 9-0 vote for no more QE – £375bn is the total so far – and no change in Bank rate, 0.5%. Neither he nor anybody else was outvoted.
Interesting though these developments were, they represented the appetisers to next month’s main course, to be unveiled on August 7. While many will be enjoying the beach, the Bank under its new governor will set the tone and parameters for Britain’s monetary policy over the next few years.
Does it mean we have seen the last of QE? Though I would not mourn its passing it is too early to conclude, as some have done, that there will be no more. The International Monetary Fund, in a comprehensive report on the British economy, its so-called Article IV consultation report, said the Bank should consider more QE, alongside other policies.
Even the minutes of the 9-0 vote left the door ajar for more QE, with those who had previously been enthusiastic agreeing that “an expansion of the asset purchase programme remained one means of injecting stimulus, but the committee would be investigating other options during the month, and it was therefore sensible not to initiate an expansion at this meeting”.
Having said that, QE will not be the focus next month. It will be the policy most associated with the new governor, forward guidance on interest rates.
In the March budget, having talked to Carney, George Osborne updated the Bank’s remit to make clear, as he put it, that the MPC “may wish to issue explicit forward guidance, including using intermediate thresholds in order to influence expectations on the future path of interest rates”.
There is a danger, in the language used by the chancellor, and talk of intermediate thresholds and “state-contingent” forward guidance, of complicating a very simple idea. That idea is that interest rates will not be raised until certain conditions are met, and the Bank is working on its formulation for what those conditions should be.
It could be the unemployment rate, the measure used by the Federal Reserve. The US unemployment rate is currently 7.6% and the Fed is looking for 6.5% before it tapers its QE programme (its additional asset purchases) to zero.
Britain’s unemployment rate is 7.8% and, according to the Office for Budget responsibility’s latest forecast, will be 6.9% as late as 2017, implying on a 6.5% rule no increase in interest rates before then.
An intermediate unemployment threshold is not perfect – you can have strong economic growth which is not reflected in a drop in unemployment if the workforce is expanding – but is likely to be part of next month’s guidance.
Other variables are being examined, including the “output gap”, the amount of spare capacity in the economy, which is hard to measure. Above-trend growth, and the number of quarters it is achieved (if and when), and the level of “money” GDP merit consideration.
I suspect, however, the Bank will want to keep it simple, finding the most straightforward way of conveying the message that rates will be kept low until such time as growth is properly established, as measured by unemployment. There will be caveats: an exchange-rate crisis or domestically-generated inflation surge could force the MPC to override its guidance. But that will be the aim.
Will forward guidance work? It is important to recognise that not doing something can still provide a stimulus. So even if there were to be no more QE, the £375bn already done, which will not be unwound until well after interest rates have risen, is still providing a monetary boost.
Similarly, and perhaps more obviously, not raising interest rates, or holding them down beyond the point firms and individuals might have expected them to rise, should stimulate some growth.
It will not be a panacea. The victims of low rates, savers and particularly pensioners, will shout even louder about the iniquities of indefinitely low rates. It will not prevent, say, 10-year bond yields from rising if, led by stronger US data, that is where markets want to take them.
The IMF, in its assessment, said forward guidance is unlikely “by itself” to instigate recovery, citing the need to boost the supply of credit. With the latest figures from the Bank showing a continued drop in len ding to small and medium-sized firms, even with the Funding for Lending scheme in place, it is a point well made.
Though this week’s figures should show growth picking up significantly in the second quarter – the Bank expects 0.6% – there is a long way to go. Forward guidance is definitely worth trying. But that box of tricks may have to be raided again.