Mark Carney will get a chance this week to explain what happened to forward guidance.
Just weeks after entrenching investor expectations on record-low interest rates, the Bank of England governor warned borrowing costs may rise earlier than anticipated. His change of tone will probably feature at questioning when he appears before lawmakers tomorrow.
“Carney has a massive communication problem because I think it’s just flip-flopping around,” said Brian Hilliard, an economist at Societe Generale SA in London and a former BOE official. “We get very strong signals from the BOE and they become meaningless a month later.”
At risk is Carney’s credibility as his plans to keep interest rates low run up against a strengthening recovery that’s put Britain at the vanguard of the Group of Seven nations. While the governor is sticking to the view that any increases will be “gradual,” his surprise comments in the Mansion House speech on June 12 prompted a huge shift in bets on the timing of the first tightening.
Carney will speak to Parliament’s Treasury Committee at a public meeting to grill policy makers about their quarterly Inflation Report, and he will brief journalists on the BOE’s financial stability report two days later. Among lawmakers on the panel is Conservative Jesse Norman, who questioned last week whether forward guidance is still a relevant policy.
“Where’s the substance?” Norman said on June 18. “All it really amounts to is a lot of arm waving until the governor tells us when he thinks rates are going to go up or down.”
In May, the BOE’s Monetary Policy Committee said inflation would probably stay close to its 2 percent target over the next three years, based on expectations for a rate increase in the second quarter of 2015. Four weeks later, Carney said the MPC could move “sooner than markets currently expect.”
The shifting position was reinforced last week, when the MPC said in the minutes of its June meeting that it was “surprising” that investors were putting such a low probability on a rate hike this year. The BOE has held its benchmark rate at 0.5 percent since March 2009.
The pound surged 1.6 percent versus the dollar this month, as the prospect of higher rates boosted its allure. Sterling rose to $1.7063 on June 19, the strongest level since October 2008, and was at $1.7021 at 10:40 a.m. London time.
Policy maker David Miles wrote in today’s Telegraph newspaper that it’s now “much more likely” rates will start to return to normal before his term on the MPC ends May 31. It’s a contrast from comments made in February, when he said “it may be that sometime next year may be the right time, but it’s difficult to predict.”
The change of view is “obviously going to be a key debating point of the Treasury Select Committee,” said George Buckley, an economist at Deutsche Bank AG in London. “How -- in terms of communication -- you’ve gone from the position where the MPC has been giving very dovish signals, to one where they are giving much less dovish signals.”
Societe Generale’s Hilliard, along with economists at Barclays Plc, Credit Suisse Group AG and Royal Bank of Scotland Group Plc, were among those who brought their rate forecasts forward after Carney’s comments. The implied yield on short-sterling futures contracts expiring in December rose to 0.90 percent at the end of last week, compared with 0.72 percent on May 30.
Under the first phase of guidance, which Carney introduced one month after he took office last July, the BOE said it wouldn’t raise rates at least until unemployment declined to 7 percent, something it didn’t see happening until 2016 at the time. In February, officials were forced to redraft the policy after joblessness fell far faster than anticipated, changing the focus to spare capacity in the economy.
“Guidance was designed for a certain set of circumstances, which have now changed,” said Stuart Green, an economist at Santander SA in London. “The market isn’t questioning their credibility just yet, but there are implications. If the bank was wrong in the first place, then why should they be believed now?”
Britain’s economy expanded 0.8 percent in the first quarter and is set to maintain that pace in the second quarter. While inflation is below the BOE’s 2 percent target, continued economic strengthening could reduce the amount of slack faster than forecast, raising the prospect of increased price pressures.
For David Tinsley at BNP Paribas SA in London, the recent adjustment within the MPC may just be the start, with the next shift possibly centering on the speed of rate increases.
“There is a clear risk that the MPC will eventually need to change its tune, again, on the speed and degree of tightening that the economy will need,” he said.