August was not a quiet month at the Bank of England.
The new Governor of the Bank of England, Mark Carney, came to the job with a ‘rock star’ central banker reputation which his predecessor, Sir Mervyn King, lacked. Mr Carney was expected to reform the Bank’s policies and in August he took a major step in this direction.
What he did was make an announcement which fits the economic euphemism of the moment, ‘forward guidance’. At its simplest, forward guidance means telling the market the central bank’s views of (and plans for) future short term interest rates. However, in the UK context it was not that simple. Mr Carney told us that the Bank “intends not to raise Bank Rate from its current level of 0.5% at least until … the unemployment rate has fallen to a threshold of 7%”, which the Bank’s economists predict will be in mid- 2016. The current (April-June) unemployment figure is 7.8%.
It was not – despite the various “another three years” headlines – a blanket promise. The Bank detailed three “knockouts” (its words) that would prompt earlier action:
- The Bank considers it more likely than not, that CPI inflation 18-24 months ahead will be 2.5% or more;
- Medium-term inflation expectations no longer remain “sufficiently well anchored”; and
- A significant threat to financial stability related to the continued low rates.
The Bank (and the Chancellor’s) hope is that the guidance encourages companies and consumers to borrow, safe in the knowledge they will not be hit by a sudden rise in rates. Mr Carney used a similar approach in his last job, at the Bank of Canada, when he said in April 2009 rates would stay flat for at least a year…….
But the market has other views
The market is unconvinced by Mr Carney’s 2016 target.
One of the reasons why ‘forward guidance’ is a relatively new idea is that central bankers are a cautious bunch who avoid making themselves a hostage to fortune. Mr Carney’s three ‘knockouts” give him some wriggle room, but the more flexibility there is, the less the credibility of the forward guidance.
Since the guidance was issued, interest rates have generally been rising. For example, on the day of the announcement (1 August), five year government bonds (gilts) were yielding 1.42% according to the Bank of England, whereas by the end of the month their yield was 1.71%, having fallen back from 1.8%+ on Syrian concerns.
There are a variety of reasons why Mr Carney and Mr Market are at odds with each other. One is that inflation ‘knockout’: CPI inflation is currently (July 2013) running at 2.8% and has been at or above 2.5% for all but three months since January 2010. Another is the 7%
unemployment target, which some economists think could arrive well before mid-2016. However, the biggest obstacle to 2016 is probably another central banker; Ben Bernanke, chairman of the US Federal Reserve. Bernanke has said US short term rates will stay on hold until unemployment hits 6.5%, but he has also indicated that the central bank will start to cut back on its $85bn a month quantitative easing (QE) programme soon.
That has given US investment markets the jitters, pushing up US government bond yields and bringing volatility back to US share prices. Other global markets have caught Wall Street’s chill as non-US investors wonder whether rising US Treasury rates mean their countries’ rates will have to increase as well.
From a UK perspective the rises so far have had one benefit: annuity rates and income withdrawal rates have been nudged up. September’s income withdrawal interest rate of 3% is the highest since November 2011.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investing in shares should be regarded as a long-term investment and should fit in with your overall attitude to risk and financial circumstances.
13th September 2013
