Carney on Interest Rates

The Governor of the Bank of England, Mark Carney, stated today during the quarterly inflation report that there would be no interest rise until unemployment was brought under control at 7% in the UK. The FTSE 100 fell almost immediately and currently stands at 6,547.06 (down 57.15, 0.86%) today at 13.38 local time in London.

Many are seeing the new Governor of the Bank of England’s announcement today as a marked contrast to the policies of Mervyn King over the previous years. Carney stated that there would only be three conditions that would stop the Bank of England from not making a change in interest rates in the UK, which were:

  • Above-target inflation (over 2.5%)
  • Expectations of unanchored inflation (medium-term)
  • Financial stability being put on the line

Although recovery was considered in his opinion to be ‘weak’ he did state that “A renewed recovery is now underway in the United Kingdom and it appears to be broadening”. Although, he believes that Gross Domestic Product in the UK will not get back to pre-financial crisis levels until well into next year.

Governor of the Bank of England: Carney and Forward Guidance

Governor of the Bank of England: Carney and Forward Guidance

  • The pace of GDP has seen a doubling in the figure in the 2nd quarter this year in comparison with the dismal figures of the 1st quarter 2013.
  • Growth in the British economy currently stands at 0.6% and George Osborne, the Chancellor of the Exchequer in the UK, stated that ‘Britain is on the mend’ a few days ago.
  • Some might say that the recovery is overdue and should have started showing through long ago, despite the fact that it is welcome news.
  • Although, it is certainly not sustained growth quite for the moment.
  • Economists had all predicted that 0.6% would be the growth prospects of the UK in the 2nd quarter this year and they got it spot on.
  • However, clearly 0.6% is far from enough to have any marked impact on the country.

Industrial production was up from April to June in the UK, according to the Office of National Statistics (ONS).

  • The services sector of the economy also showed an increase in activity.
  • This area stands for 78% of output in the UK economy.
  • On an annual-comparative level, GDP is 1.4% higher than this time last year.
  • But, the economy in the UK must grow a further 3.3% in order to get back to the same level of economic stability that it had prior to the financial crisis of 2008.
  • There may be increasing optimism among businesses and consumers in the UK, but, that gap of 3.3% that is still in need of being closed seems a long way off.
  • Mark Carney is very upbeat about the ability of the UK economy to close that gap by the end of next year.

The Bank of England’s Monetary Policy Committee (MPC) suggested that the annual growth of the UK economy would probably reach approximately 2.4% by 2015, which is under the gap that needs to be closed according to Carney’s statement. Interest rates have never been so low in the UK and currently stand at 0.5% and they have been at that level for four years now. Carney has suggested that they will stay like that for the time being and probably well into 2014, when the growth of the UK economy has become more sustained.

Carney has laid down plans for what is termed ‘forward guidance’ of the UK economy, which he had already used when he was the Governor of the Bank of Canada.

Mark Carney and Forward Guidance

Mark Carney and Forward Guidance

  • Further guidance makes the promise that the direction of the Bank of England regarding interest rates is that it will not sway unless one of the three conditions is met above or unemployment falls below 7%.
  • The Central Bank of the UK will be prepared to intervene and use some form of Quantitative Easing as well if needs be: “if it judges that additional monetary stimulus is warranted”.
  • However, Carney went on to warn that forward guidance did not simply mean that the day unemployment reached 7% the interest rates would immediately rise.
  • Rather, he stated that the Bank of England and the MPC would consider the issue.
  • This is allowing, at least, mortgage lenders and banks to predict how long interest rates will be at such levels and act accordingly within that framework, rather than questioning what will happen in the future to them.
  • In this way, short-term interest rates are somewhat turned into long-term ones.
  • With the banks assured that they will be able to borrow at such low levels, they should (in theory) lend more to business and private individuals and thus boost economic activity.

Carney is seemingly going to use Quantitative Easing only as a means of last resort in the UK economy, worried that it will make many banks fearful of the future stability of inflated prices of investments, which will only burst once the printing presses have stopped rolling. Ben Bernanke is facing the self-same problem in the US with withdrawing QE. This is becoming more and more difficult, as the markets react almost immediately by falling whenever there is the mere suggestion of tapering.

But, despite the reassurance from Carney that interest rates would not be increased, the markets did not see it in quite the same light. The FTSE 100 fell today on the announcement regarding forward guidance and the maintaining of low interest rates in part due to the fact that the market knows only too well that despite statements, the Bank of England, like any other central bank, would go back on what it has stated if circumstances mean that this is necessary. The BoE can hardly put itself into a strait-jacket and maintain low interest rates if the economy does not allow that, despite all the promises in the world. Some have stated that Carney is only using words that are to all intents and purposes playing mind games with the economists and the market. Forward guidance had been on the table in the minds of most analysts, but what came as an unexpected surprise was the fact that Carney clearly outlined that there were clauses that would enable the BoE to back-track on that policy and renege on promises. The Carney effect may not have had the desired result on the market that had quite been expected.

But, if Carney had not used forward guidance, then the mortgage-rate increase might have knocked the wind out of the sails of the real-estate sector in the UK, which is only just gathering speed.

We shall see how the markets continue to react and whether or not the forward guidance does end up having the desired effect on the UK economy.

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