24th June 2014 by Shaun Richards
Today sees several members of the Bank of England Monetary Policy Committee giving testimony to the Treasury Select Committee about the May Inflation Report. In particular there will be plenty of opportunity to discuss these two parts of it.
Monetary policy will be set to meet the inflation target over the forecast horizon, while using up wasteful spare capacity, particularly in the labour market;
the outlook for inflation in the medium term remains benign.
That was aimed quite clearly at what was the second effort at Forward Guidance which was to affirm that interest-rates were not going up anytime soon. We now know that the Bank of England Governor had at least a partial change of heart before his Mansion House speech which switched towards hinting at an interest-rate rise. This was odd as the criteria set of “economic developments” in fact pointed in the other direction as the major piece of news in the meantime was this.
Indeed the April annual growth rate for regular pay of 0.4% was the lowest in this series which goes back to January 2001.
So inflation looks benign and wage growth undershoots expectations with the fear that the weakness looks persistent. Hardly a case for a change there. Not much of a case can be made for falling unemployment as a measure as Mark Carney dropped that only in February! Until then an unemployment rate of 7% was seen as a threshold. It would be like the verse of the song “Hokey-Cokey” to put it back in again!
In spite of the fact that there have not been economic developments to justify matters the rest of the MPC seem to be following Mark Carney’s change of mind like sheep following a shepherd. Even arch dove David Miles wrote this about interest-rate rises in the Sunday Telegraph.
But that day is coming.
Although I counsel extreme caution in using David Miles as a seer as this time last year he was voting for more Quantitative Easing on this basis according to the MPC Minutes.
Those projections implied only a modest recovery in growth and relatively little improvement in unemployment.
Since then the economy has grown by 3.1% and unemployment has fallen by 347,000 according to the latest numbers. It is hard to see how he could have been more wrong!
What are they now saying?
As I watch the live coverage of the testimony, it is clear that we are seeing yet another change of not only emphasis but also direction from the Bank of England. Let me give you a flavour of the responses to the questions asked. Firstly the issue of slack in the economy came up and Governor Carney replied that the weakness in wage growth implied that there was more slack than previously thought. David Miles pointed out that there was still a “significant degree” of spare capacity in his opinion. So two individuals who have spoken about Base Rate rises coming over the horizon have in effect just pushed them back behind it again!
In some ways there was worse to come as the newly knighted Deputy Governor Charlie Bean told us it is best to avoid “spurious accuracy” in measures such as labour market slack. Sadly nobody had the nous to ask this “top flight public servant” why the Bank of England had directed people to use a measure it could not reliably estimate?!
The emphasis and hints being provided here were added to when Governor Mark Carney pointed out that some work had suggested that the equilibrium unemployment rate (the lowest rate compatible with non-accelerating inflation) may be more like 5.5% than the 6.5% previously used. Again the clear implication was that there is more slack in the economy in his view than before. Regular readers will be aware that this move was expected.
So we are now being guided away from the hints of a Base Rate rise that came in the Mansion House speech. Whilst this is a success for my “Dark Side” theory as Mark Carney has today admitted that he was trying to influence financial markets with this speech, there is a problem. If we were in America then Mark Carney would be called a “flip-flopper” as we have had a lot of different types of Forward Guidance from an individual who has not yet been in office for a year. Others may be wondering at Mark Carney’s claim that he has met “thousands of businesses” in less than a year which is quite a rate!
Problems with the ability to count are not a strength in a central banker and obvious exaggeration leads to lower credibility.
Fine-tuning of markets
This next section needs to be reviewed in the light of the fact that the Bank of England has had a dreadful forecasting record over the credit crunch era. We were told by Governor Carney and Charlie Bean that the MPC had felt that market expectations for interest-rates were in the wrong place (too far into 2015) and that this was a driver in the thinking behind the hawkishness on this subject in the Mansion House speech. There is a breathtaking audacity in this as we review the scale of the proposed central planning here. No wonder more and more markets are seeing declining volumes as they increasingly become the playthings of central bankers. Even more extraordinary is that a group of individuals who have a shocking track record feel that they know better than the markets. I am not sure how else one can describe this except as being arrogant. Especially if we look at their track record on this particular subject. Let us remind ourselves how it was supposed to work and jump back to August 2013.
It reduces uncertainty about the future path of monetary policy as the economy recovers. In particular, it increases the understanding of financial market participants, businesses and households of the conditions under which the highly stimulative stance of monetary policy will be maintained.
Odd is it not that those “financial market participants” got it wrong when it was supposed to be a pillar of the plan. However here is the rub as Shakespeare put it. We were first told that Base Rate rises would not happen until 2016 via the forecast for achieving an unemployment rate of 7%. Forward Guidance mark two saw this move into mid-2015. Then Mark Carney at his Mansion House speech moved it firmly into 2014, and now it has been shuffled back into 2015. Exactly what sort of Forward Guidance is this? It looks a rather useless one. Who wants to be led by the blind?
It would appear that Mark Carney is a fan of the singer Luther Vandross. As this hit of his is apparently the new view on his Mansion House speech.
And I really didn’t mean it
Out of my head to say the things I said
I didn’t mean a word
You could argue that this covers the four versions (including today’s) of monetary policy that we have now had from him. After all he has changed pretty much everything short of ever actually raising Base Rates. The “flip-flopper” badge will remain in people’s minds for quite some time which is exactly the reverse of the claimed impact of Forward Guidance. Perhaps markets have come to the same view as the UK Pound is edging back towards US $1.70 again.
One of the ironies of the situation is that a Bank of England paper has argued that a Base Rate rise would in fact have a relatively small impact on the UK economy. From a Working Paper.
We find that a 1 percentage point increase in the policy rate reduces output by up to 0.6% and inflation by up to 1.0 percentage point after two to three years.
If they are right then the whole debate about the first Base Rate rise is being given too great a significance by the Bank of England.