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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Geoffrey Howe dies, aged 88

Howe was Margaret Thatcher's longest serving Cabinet minister – and the man credited with precipitating her downfall.

The former Conservative chancellor Lord Howe, a key figure in the Thatcher government, has died of a suspected heart attack, his family has said. He was 88.

Geoffrey Howe was the longest-serving member of Margaret Thatcher's Cabinet, playing a key role in both her government and her downfall. Born in Port Talbot in 1926, he began his career as a lawyer, and was first elected to parliament in 1964, but lost his seat just 18 months later.

Returning as MP for Reigate in the Conservative election victory of 1970, he served in the government of Edward Heath, first as Solicitor General for England & Wales, then as a Minister of State for Trade. When Margaret Thatcher became opposition leader in 1975, she named Howe as her shadow chancellor.

He retained this brief when the party returned to government in 1979. In the controversial budget of 1981, he outlined a radical monetarist programme, abandoning then-mainstream economic thinking by attempting to rapidly tackle the deficit at a time of recession and unemployment. Following the 1983 election, he was appointed as foreign secretary, in which post he negotiated the return of Hong Kong to China.

In 1989, Thatcher demoted Howe to the position of leader of the house and deputy prime minister. And on 1 November 1990, following disagreements over Britain's relationship with Europe, he resigned from the Cabinet altogether. 

Twelve days later, in a powerful speech explaining his resignation, he attacked the prime minister's attitude to Brussels, and called on his former colleagues to "consider their own response to the tragic conflict of loyalties with which I have myself wrestled for perhaps too long".

Labour Chancellor Denis Healey once described an attack from Howe as "like being savaged by a dead sheep" - but his resignation speech is widely credited for triggering the process that led to Thatcher's downfall. Nine days later, her premiership was over.

Howe retired from the Commons in 1992, and was made a life peer as Baron Howe of Aberavon. He later said that his resignation speech "was not intended as a challenge, it was intended as a way of summarising the importance of Europe". 

Nonetheless, he added: "I am sure that, without [Thatcher's] resignation, we would not have won the 1992 election... If there had been a Labour government from 1992 onwards, New Labour would never have been born."

Jonn Elledge is the editor of the New Statesman's sister site CityMetric. He is on Twitter, far too much, as @JonnElledge.