My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.
Mark Carney has been Bank of England governor for just seven weeks but already we have had the first tiff on the monetary policy committee (MPC). His relationship with the markets, meanwhile, is approaching the plate-throwing stage.
The new governor is finding his eight colleagues on the MPC - all men - can be an argumentative bunch. His actions are subject to closer scrutiny in the cauldron of the City of London than when he was setting rates for Canada in gentler Ottawa.
Carney gave the first hint of his new policy of forward guidance on interest rates on July 4, when the MPC issued a statement saying the rise in market interest rates was unwarranted, and not justified by anything the Bank was planning to do.
The bells and whistles version of the new approach, unveiled at Carney’s first inflation report press conference on August 7, gave us the now familiar 7% unemployment threshold, at which point - barring accidents - the MPC will begin contemplating interest rate hikes. On the Bank’s forecasts that will not be until 2016.
That was not the end of the story. A few days ago we had the minutes of the August MPC meeting at which forward guidance was agreed. They showed one member, Martin Weale, unhappy with one whistle associated with the policy: one of the so-called inflation “knockouts”, which will override the 7% unemployment rate.
Instead of a Bank forecast of inflation above 2.5% in 18-24 months’ time, Weale would have preferred a more timely warning of above-target inflation, perhaps a year out. Not only that, but other unnamed MPC members did not think the markets, which are pricing in rate hikes well before 2016, were obviously out of line.
To add to the mix - some say the confusion - other MPC members, presumably ultra-doves Paul Fisher and David Miles, have not given up on quantitative easing. They think the case for adding to the Bank’s £375bn of QE remains “compelling” and may vote for it in the coming months.
All this did not go down too well in the City. Ross Walker of Royal Bank of Scotland said the forward guidance framework was “less robust or cohesive” than expected.
Rob Wood of Berenberg Bank called it “Undermining a policy the Bank of England way”. “Markets are unconvinced over the extent to which the MPC will commit to its forward guidance,” said Investec’s Philip Shaw. Harshest was Nick Beecroft of Saxo Bank, who said: “Forward guidance is hardly worth the paper it is written on.”
The markets, apart from pricing in the first rate hike sooner than 2016, have pushed up the yield on government bonds - 10-year gilts - to their highest since 2011 and a percentage point above where they were in the spring. Both amount to a tightening of policy at a time when the new governor is saying it will stay loose.
So is it all up for Carney’s forward guidance when it has barely begun? Despite saying that this is not the best designed policy in the world I do not think so.
Anybody relying on markets for rate guidance recently would have been caught out badly. From March 2009, when Bank rate was cut to 0.5%, the market default position has been to price in rate hikes. Those expectations never came to pass.
The current situation, in which strong economic data runs up against the Bank’s commitment to keep rates low, is exactly the one which will test the strategy. Carney’s arrival coincided with a sustained burst of activity but I do not think he will mind that. Had his launch of forward guidance come at a time of moribund activity, nobody would have paid much attention.
The battle between markets convinced it will not take much of an economic lift to force a rate hike and a governor saying it will take a lot to do so will be a fascinating one. For forward guidance to work it is a battle he has to win.
Though it is as important for firms and individuals to believe low rates are here to stay, rising market rates affect borrowing costs in the wider economy, so need to be nipped in the bud.
Some of that battle will be settled by the data. If inflation continues to fall, as last week, dropping to 2.8% in July, it will calm talk of higher rates. If the unemployment rate is slow to fall that will do so too.
While there are City economists who think 7% unemployment could be hit quite soon, that looks optimistic.. The Bank says even if 250,000 net new jobs are created a year, 7% will not be achieved until 2016.
Recent experience suggests it could be longer. In the past year a 301,000 rise in employment resulted in only a small drop in the unemployment rate, from 8% to 7.8%. With that kind of progress it could require 1.2m net new jobs, and at least four years, to get down to the threshold.
Only if productivity really has permanently collapsed, and it does not take much growth to get unemployment down, would 7% be reached much faster. In those circumstances, the Bank would be right to worry.
What about the MPC minutes and Weale’s dissent? Two things. The MPC, including Weale, will operate on the basis of the framework adopted 8-1 by the majority. As importantly, the discussion about the inflation “knockouts” shows the Bank has not abandoned its commitment to 2% inflation. That, given some of the initial worries about the new strategy, should be positive for Britain’s monetary policy.
As for rising 10-year gilt yields, the new governor is probably realistic about his ability to influence them. They partly reflect international developments, not least events in America. They also reflect the view that such yields, which have been exceptionally low, have to normalise at some time. I doubt the Bank thinks it can or should try to stop that happening.
The big picture is that the new policy is bedding-in, with some teething troubles, not that it has stalled or failed.
The possibility remains that Carney will only resolve his battle with the markets with actions as well as words. That could involve him joining ultra doves in voting for more QE, which I hope he does not do.
It could mean the Bank contemplating a Bank rate cut from 0.5% to 0.25%, to underline its dovishness, though it will be reluctant to do that for fear of upsetting the operation of the money markets.
More likely will be more words. So far we have only really heard from Carney on forward guidance with no strong sense of how genuinely committed the rest of the MPC is to the new strategy. A few speeches from them could help resolve the market doubts.