Bank of England joins the "forward guidance" party

The Bank of England's Monetary Policy Committee has announced that they will adopt "forward guidance" - a move which could prove psychologically self-defeating, or worse financially ruinous.

A few weeks ago I wrote in this blog that I felt the adoption of "forward guidance" by the Bank of England’s Monetary Policy Committee would be a mistake. Well, as expected, they did so, in an announcement timed to coincide with the publication of the Bank’s August Inflation Report -the quarterly document which lays out the Bank’s perception of the current state of the economy and forecasts for its performance over the next few years.

In that previous blog I highlighted the danger that forward guidance could inflict self-defeating psychological damage upon people and businesses by telling them, effectively, to ignore the good economic headlines that are increasingly appearing in the newspapers - i.e. the Bank of England doesn’t believe a word of it, and therefore won’t be raising interest rates for years to come.

The other side of the coin is potentially as dangerous. The form of guidance adopted was an assurance that the Bank wouldn’t raise rates until unemployment hit 7.0 per cent, (it is currently 7.8 per cent, and the Bank’s Report expects it to fall to 7.0 per cent only in mid-2016). In a vain attempt to preserve what’s left of the MPC’s credibility as an inflation fighter, caveats, or "knock-outs", were added to this promise. There were three of these: they wouldn’t wait that long to tighten policy if they thought a) inflation was going to be above 2.5 per cent in eighteen months to two years' time, b) inflation expectations became "unanchored", or c) "the stance of monetary policy pose[d] a significant threat to financial stability".

The nightmare scenario for the Bank, and for us all, is that policy has to be tightened because one of the "knock-outs" has been triggered before unemployment has fallen meaningfully. Imagine a world, 12 or 18 months hence, where either "knock-out" a) or b) is triggered, but unemployment is stuck stubbornly at 7.2 per cent. Given what's happening in the housing market, the prospects for acceleration thereof following this guidance, and the UK economy’s propensity to exhibit high inflation, I see a real danger that knock-out b) is the problem.

On the other hand, given the "productivity puzzle", (in this recession, productivity has dropped, and unemployment has risen less than one might normally expect), the stage seems set for productivity to rise, at the expense of employment, especially as employers become more confident and commit to long-delayed capital investment in new, more efficient plants and machinery.

If either inflation "knock-out" is triggered within the 12 to 18 months time horizon I mentioned above, that is a lot sooner than the date at which the Bank of England’s own forecasts expect unemployment to hit 7 per cent, i.e. mid-2016, (and Carney assures us 7 per cent is only a "way station" anyway, not a "trigger" for higher rates), and the danger here is that individuals and businesses are now fooled into taking on more and more debt, comforted by the Bank’s prediction that rates will stay where they are for almost another 3 years at a minimum, and the UK can already hardly be characterised as a country with low private debt. If rates do have to rise much sooner than this, then loan delinquency could sky rocket.

Outside the Bank of England. Photograph: Getty Images.

Chairman of  Saxo Capital Markets Board

An Honours Graduate from Oxford University, Nick Beecroft has over 30 years of international trading experience within the financial industry, including senior Global Markets roles at Standard Chartered Bank, Deutsche Bank and Citibank. Nick was a member of the Bank of England's Foreign Exchange Joint Standing Committee.

More of his work can be found here.

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Why relations between Theresa May and Philip Hammond became tense so quickly

The political imperative of controlling immigration is clashing with the economic imperative of maintaining growth. 

There is no relationship in government more important than that between the prime minister and the chancellor. When Theresa May entered No.10, she chose Philip Hammond, a dependable technocrat and long-standing ally who she had known since Oxford University. 

But relations between the pair have proved far tenser than anticipated. On Wednesday, Hammond suggested that students could be excluded from the net migration target. "We are having conversations within government about the most appropriate way to record and address net migration," he told the Treasury select committee. The Chancellor, in common with many others, has long regarded the inclusion of students as an obstacle to growth. 

The following day Hammond was publicly rebuked by No.10. "Our position on who is included in the figures has not changed, and we are categorically not reviewing whether or not students are included," a spokesman said (as I reported in advance, May believes that the public would see this move as "a fix"). 

This is not the only clash in May's first 100 days. Hammond was aggrieved by the Prime Minister's criticisms of loose monetary policy (which forced No.10 to state that it "respects the independence of the Bank of England") and is resisting tougher controls on foreign takeovers. The Chancellor has also struck a more sceptical tone on the UK's economic prospects. "It is clear to me that the British people did not vote on June 23 to become poorer," he declared in his conference speech, a signal that national prosperity must come before control of immigration. 

May and Hammond's relationship was never going to match the remarkable bond between David Cameron and George Osborne. But should relations worsen it risks becoming closer to that beween Gordon Brown and Alistair Darling. Like Hammond, Darling entered the Treasury as a calm technocrat and an ally of the PM. But the extraordinary circumstances of the financial crisis transformed him into a far more assertive figure.

In times of turmoil, there is an inevitable clash between political and economic priorities. As prime minister, Brown resisted talk of cuts for fear of the electoral consequences. But as chancellor, Darling was more concerned with the bottom line (backing a rise in VAT). By analogy, May is focused on the political imperative of controlling immigration, while Hammond is focused on the economic imperative of maintaining growth. If their relationship is to endure far tougher times they will soon need to find a middle way. 

George Eaton is political editor of the New Statesman.