Carney Guidance Policy Risks Backlash at BOE: U.K. Credit
Bank of England Governor-designate Mark Carney’s signature stimulus policy is running into opposition from current and former U.K. central bankers.
As the Bank of Canada chief prepares to take the helm of the U.K. institution on July 1, he is probing whether to import the practice of telling investors how long low interest rates will last. Another option is copying the Federal Reserve by setting thresholds that dictate the lifespan of easy money.
The theory behind “forward guidance” is that it boosts weak economies by lowering the anticipated path of rates or lifting expectations that higher inflation will be tolerated. The risk for the U.K. is it may not mean much of a growth fillip and could spur prices. Bank of England Governor Mervyn King says the policy may hurt the credibility of monetary policy, with U.K. inflation expectations already the highest in the Group of Seven as measured by breakeven rates.
“I’m very much a skeptic on forward guidance,” former policy maker Adam Posen, who left the Bank of England last year and has called forward guidance “cheap talk,” told a Bloomberg Link conference in Washington on April 30. “It’s not clear to me why central bankers making a verbal statement is anything more than any other kind of market signal they do.”
Challenged with achieving what he calls “escape velocity” for the U.K. economy, and with the benchmark rate at a record-low 0.50 percent, Carney succeeds King with a mandate from the government to report in August on the pros and cons of trying to support the economy via forward guidance.
It’s a strategy he knows well. In April 2009, he pledged to keep Canada’s benchmark rate at a record low until mid-2010 so long as the inflation outlook didn’t change.
The experiment “succeeded in changing market expectations of the future path of interest rates, providing the desired stimulus and thereby underpinning a rebound in growth and inflation,” Carney said in a December speech.
Speaking yesterday in Edmonton, he said “guidance allows a central bank to substitute duration and greater certainty regarding the interest-rate outlook for the negative interest-rate setting that may be warranted but cannot be achieved.”
The Fed went further than Canada in December by tying changes in its benchmark directly to indicators for employment and inflation.
Fed Bank of San Francisco economists endorsed the case for better communications in the U.K. by estimating in November that about 60 percent of the recent decline in U.S yields reflected lower expectations for rates. None of the drop in U.K. yields was driven that way, they said. The 10-year Treasury yield fell to 1.62 percent from 1.69 percent in November, while the similar maturity gilt yield fell to 1.77 percent from 1.85 percent.
Not all are convinced and some skeptics sit on the nine-member Monetary Policy Committee that Carney will lead. “Forward guidance, particularly if it’s associated with thresholds, in the British context, does have problems,” policy maker Martin Weale said in an April 18 interview.
Posen, now president of the Peterson Institute for International Economics in Washington, questions the success of the U.S. and Canadian strategies, arguing financial markets sometimes moved contrary to what the commitment of central banks would suggest as new economic information landed.
One question for the U.K. is what would it achieve given investors don’t predict the Bank of England will raise its benchmark rate before 2016, according to short sterling futures. The bank already gives information on its thinking in its quarterly inflation report, policy maker Paul Fisher said in a February speech.
The yield curve “is so flat I’m not clear how much it would buy,” MPC member Ben Broadbent said of guidance late yesterday in London.
With U.K. consumer-price inflation above the 2 percent target for more than three years, there are doubts about how lasting any pledge to ignore rising prices could be and such a commitment risks pumping up inflation expectations, according to Brian Hilliard, an economist at Societe Generale SA in London.
Inflation held at 2.8 percent in March and the U.K. 10-year breakeven rate, a gauge of expectations of inflation derived from the difference in yield between regular and index-linked bonds, is at 3.1 percentage points, Bloomberg data show. Canada’s (CDGGBE10) 10-year breakeven rate is 1.88 points, below its 2 percent inflation target.
Meantime, U.K. unemployment of 7.9 percent is low for an economy that is struggling to establish a recovery, according to Hilliard, suggesting Britain suffers from poor productivity that leaves it prone to higher inflation. If the U.K. sets a jobless threshold much below the current rate, productivity could fall further, helping to propel inflation, he said.
For Richard Barwell, a former Bank of England economist now at Royal Bank of Scotland Group Plc, the risk of forward guidance is that consumers or investors may conclude the central bank is pledging to keep rates low no matter what, when in reality it could have to shift gears if inflation picks up.
“The message could get lost in translation,” he said. “All the qualifiers would be lost and then as inflation or unemployment changes the central bank is forced to raise rates, surprising everyone and damaging it.”
The danger of having to renege on a commitment is a challenge flagged by King, who said last month he would be a “little bit cautious” about giving guidance. He has called it a “mistake to try and pretend” future decisions.
Weale said he and his colleagues could “find ourselves either saying we’ve changed our mind, which would be a problem, or we’d have to tighten policy at a time when, as it turns out, no one on the committee has been voting for that.”
Carney has rejected the idea of being trapped, saying April 18 that if the commitment’s limits are breached then “the threshold comes off.” He said yesterday he didn’t want to ’’prejudge’’ the debate in the U.K.
Amit Kara, an economist at UBS AG and formerly at the Bank of England, estimates the benefits may not be worth the potential costs. He calculates Canada’s signposting reduced the country’s yield curve for overnight indexed swaps by about 15 basis points. Assuming the same effect in the U.K., that may lift growth by less than 0.1 percentage point of gross domestic product.
“Why expose yourself to the credibility risk for what seems a small gain,” said Kara.
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