My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.
The Bank of England has got itself into a terrible tangle over interest rates, which is threatening to make it look rather foolish.
The big question for monetary policy was how, after more than five years with Bank rate at a record low of 0.5%, the Bank would approach the tricky task of managing the first of what will be a sequence of hikes.
We have become so used to announcements of unchanged rates each month from the Bank that the first move was always going to be a very big story. Maybe not on the scale of the moon landing but big nonetheless.
So far at least, the Bank has botched the job of preparing the ground for that first hike. And I am afraid the buck for this has to stop with Mark Carney, the big-bucks earning Bank governor.
In August last year Carney launched forward guidance, which tied the point at which the Bank’s monetary policy committee (MPC) would begin considering rate hikes to the unemployment rate. The MPC would not necessarily hike rates when unemployment hit 7% but it would think about it. But, because unemployment was unlikely to fall that much until 2016, people and businesses could relax.
We all make mistakes and, though the outgoing deputy governor Charlie Bean disagrees, it was a mistake to link rate decisions to so wayward a mistress as the unemployment rate. As it is, figures this month showed it has already dropped to 6.6%.
But the policy had its heart in the right place; allowing the recovery time to breathe before the Bank started to withdraw the exceptional stimulus implied by a 0.5% Bank rate. That, at least, was the right thing to do.
The problems came this year. In February, when it was clear that unemployment was falling more rapidly than the Bank expected, the original forward guidance was re-cast in the Bank’s inflation report. Interest rate moves would still be informed by spare capacity, but on the basis of a range of indicators rather than just unemployment. Most significantly, out of this fuzzier guidance, the Bank – and Carney – acknowledged that the market path for interest rates, a gradual rise starting next year, was not a million miles from what the Bank had in mind.
What should have happened then, as the economy strengthened, was a reinforcement of this message in May, the next inflation report. Growth had picked up strongly, the governor should have said, and this logically added to the case for raising rates.
Instead, we had the madness of May, when Carney appeared to bend over backwards not to endorse the market view on rates, even a rise in the first half of next year, and none of his MPC colleagues moved to correct him. As far as markets were concerned, the signal was clear. Howard Archer of IHS Global Insight said it “put to bed” the idea of a rate hike before the end of 2014. Capital Economics said it cooled expectations of a hike even in the first quarter of 2015.
After the madness of May came the lurch of June, starting with one sentence in Carney’s June 12 Mansion House speech, in which he said rates could rise sooner than markets expect and continuing with last week’s June minutes, in which the MPC said (for a second time) that the decision on rates was becoming more balanced and that the low probability attached in the markets to a hike this year was “somewhat surprising”.
To say I was flabbergasted to read that understates it. When the message in May rang loud and clear that markets should not get ahead of themselves in pricing in rate rises, why should anybody have factored in a 2014 hike? And if the 15% probability the markets were attaching to a 2014 rate rise when the MPC met two weeks ago was too low, what is the right probability now: 40%, 70%, 100%?
What will happen? Everybody has been looking for the first vote on the MPC for a rate hike, which will then pave the way for a gradual shift of opinion on the committee. Some in the markets were disappointed that Martin Weale, seen as the most likely to break ranks first, did not do so earlier this month.
We are more likely, I think, to see the MPC shifting en masse. Danny Gabay of Fathom Consulting notes, and not in an approving way, the fact that a remarkable “unanimity and harmony have reigned” on the committee “at a time when uncertainty over the UK economy is so high”.
Now, that unanimity appears to be extending to the question of when and by how much interest rates will rise. In the past few days we have heard from most MPC members, including Weale, David Miles, Bean, Ian McCafferty and Andy Haldane.
The view they are expressing is almost identical, though they have managed to find different ways of saying it, including what may be the most analogy-rich speech in the Bank’s history from Haldane. If we thought the sporting analogies had left the Bank with Mervyn King, Haldane’s “corridor of uncertainty” speech proved us wrong, which ended by saying it is probably better for the Bank to be on the front foot.
Even the newest recruit to the MPC, the American academic Kristin Forbes, who admits she has a lot to learn about the British economy (and worryingly says she will be talking to the International Monetary Fund to find out more) told MPs that the committee’s main challenge over the next three years will be “normalizing” monetary policy, Normalizing is Bank-speak for raising interest rates.
The view they are commonly expressing is no rate rise yet but, if we want to limit the eventual rise to 2.5% to 3%, better not to leave it too long. An early rate rise, a stitch in time, will help limit the eventual peak. That is this month’s view anyway.
When? All this “will they, won’t they” speculation is going to get very wearing very quickly. It feels like the MPC, unsure of its ground, is through minutes and speeches undergoing a collective public therapy session. By the time they do get around to raising rates – and November is the current favourite – we will all have been bored into submission.
I think they should put us out of our misery. If they think rates have to rise – and there seems to be no argument about that – and if they also think that an early hike will genuinely mean that rates can be held below 3% in the medium-term, why wait?
There are risks – the crisis in Iraq and the rise in the price of oil is one such risk now – but there are always risks. Having clumsily prepared the ground for higher rates, the MPC should get on with it. August, when the changes in MPC personnel will have fully taken effect, is probably the earliest it could happen. But August, when the Bank publishes its new quarterly inflation report, also fits in that respect. Don’t dither, do it.