Is the Bank of England really giving us Forward Guidance for an interest-rate rise again?

Yesterday saw a potential element of Groundhog Day or perhaps some truth in the words of the great Yogi Berra.

It’s deja vu all over again

Kristin Forbes of the Bank of England gave a speech in Leeds and the crucial sentence is below.

In my view, if the real economy remains solid and the pickup in the nominal data continues, this could soon suggest an increase in Bank Rate.

This of course reminds us of the period where the Bank of England gave us Forward Guidance when it hinted and sometimes strongly hinted at a Bank Rate rise. An example of this was provided by Governor Mark Carney at Mansion House in the summer of 2014.

The MPC’s current guidance makes clear that we will set monetary policy to meet the inflation target while using up that spare capacity. This has implications for the timing, pace and degree of Bank Rate increases. There’s already great speculation about the exact timing of the first rate hike and this decision is becoming more balanced. It could happen sooner than markets currently expect.

That last sentence sent markets into a frenzy as they adjusted to expectations of an interest-rate rise that year. Of course that was misguidance but that did not deter Governor Carney from hammering out the same old song in March 2015.

The Bank expects to return inflation to target within two years and to make limited and gradual increases in Bank Rate over the next three years in order to achieve that in a sustainable manner.

In January of last year he was hinting again albeit in a weaker manner perhaps affected by the accusations that he had been like an “unreliable boyfriend”

That means we’ll do the right thing at the right time on rates……….The journey to monetary policy normalisation is still young.

Actually the journey never started as of course last August the Bank of England folded like a deck chair and not only cut Bank Rate but embarked on more Quantitative Easing including that of Corporate Bonds.

Why does Kristin Forbes think this?

She claims that she expected a stronger economy.

I have consistently voiced concerns about whether the economy would prove stronger than in earlier MPC forecasts – largely due to a scepticism (based on the evidence discussed above) that heightened uncertainty would have as large a drag on growth as predicted in the short-term. But I also could not dismiss the arguments made for why the economy could slow by as much as in the best collective forecast.

Although as you may well have already noted this is classic on the one hand but on the other hand stuff. A bit like at the Inflation Report last week when Governor Carney informed us that interest-rates might go up or down! But in essence the case for an interest-rate rise is based on inflation trends.

On the other side, annual CPI inflation is expected to increase to 2.8% in the second quarter of 2018, and remain elevated so that it still averages 2.5% over 2019. This persistent overshoot of inflation above the 2% target, in and of itself, might provide a basis to tighten monetary policy

She goes further here.

More specifically, in my view, an overshoot of inflation to almost 3% was just tolerable when combined with a substantially larger deterioration in unemployment and demand than expected today.

There is of course a confession there that the Bank of England was wrong about the economic prospects for the UK post the EU leave vote or as some would put it scaremongering. Let us go back to the August 2016 Inflation Report.

The vote to leave the European Union is likely to affect GDP growth through a number of channels…… domestic demand growth is likely to slow over the near term as greater uncertainty and lower confidence drag on activity.

Of course it did not and here is the rub. These forecasting errors caused near panic at the Bank of England and we saw it adopt what it called a “Sledgehammer” of easing. What did our doubting warrior Kristin Forbes actually do?

All members of the Committee agreed that policy stimulus was warranted at this time, and that Bank Rate should be reduced to 0.25% and be supported by a TFS.

As you can see she voted for a Bank Rate cut and the bank subsidy called the Term Funding Scheme or TFS. She did vote against the Corporate Bond QE on her own and with 2 other voted against the extra Gilt purchases. How long did that last? Just over a month as the September 2016 Minutes tell us.

However, given the potential costs to the economy of immediately reversing the programme underway, they would not vote against the continuation of that programme for now. For Kristin Forbes, these arguments also applied to the corporate bond purchase programme.

Simply extraordinary! What was that about folding like a deck chair? It left the Bank of England looking like a bunch of Carney’s cronies at a time when there were genuine doubts. For example I pointed out on here and on the media such as BBC Radio 4’s Moneybox that a powerful stimulus had been applied to the economy from the lower UK Pound. Even worse Kristin herself had given speeches on the impact of changes in the value of the UK Pound on the UK economy.

The impact of exchange rate movements is even greater for the more open United Kingdom. Traded goods and services constitute over 60% of the UK economy. Currency movements directly affect the competitiveness of exports and import-competing domestic firms, and therefore production, employment, and profitability in both of these sectors. About 80% of sales by companies in the FTSE 100 are earned overseas.

So she was aware but did not have the courage of her convictions and beliefs.

Oh and this on forecasting records is woeful.

But I will show you that the Bank of England has actually done quite well

Anybody spot the catch which involves rewriting history?

What is most striking is how well forecasts for the six months after the vote have performed for most real variables – that is – forecasts made before the referendum based on a Remain vote.

Comment

I write this today with a tinge of sadness as I have praised the work and intelligence of Kristin Forbes in her time at the Bank of England. However since August she has behaved as if she has forgotten her principles and intellectual ability and if she was a man we would say she lacks cojones. What is the equivalent phrase for a woman?

Even worse the person who wants to give us forward guidance about an interest-rate rise in a speech acted rather differently only last week. From the Bank of England Minutes.

The Committee voted unanimously in favour of all three propositions.

In fact as there was an £11.6 billion Gilt maturity she voted for more QE which if you look at her claimed views is an even worse decision than her folding last September as we now know that the economy did not collapse in the meantime. Accordingly she is giving us forward guidance that looks like a house of cards built on shifting sands.

Even worse I expect this “stimulus” she has voted for to in fact have a contractionary effect on the UK economy. From the Bank of England Agents earlier today.

Indeed, the average pay settlement was expected to ease in 2017 to 2.2% from 2.7% in 2016

As the Bank of England “looks away now” and not only ignores rising inflation but with its policy easing gives it a push then real wages will fall. Thus the same mistake will be made that was made in 2011 where the so-called stimulus turned into a contraction as inflation rose in that instance to ~5%. That is the saddest part which is that a mistake is on its way to being repeated.

Oh and she credited William Phillips ( of the Phillips Curve) with a Nobel prize he never received presumably confusing him with the physicist of the same name. In a sign of low standards that has now been redacted with no acknowledgement.

Maersk

This has reported troubles today. From MSN news.

A.P. Moller-Maersk A/S halved its dividend Wednesday and reported a massive quarterly net loss as the dire conditions in the shipping industry took a further toll on its business, though it said it expects demand to regain strength this year…….The company’s net loss for the quarter ended Dec. 31 was $2.68 billion, compared with a loss of $2.51 billion a year earlier. Revenue fell 2.6% to $8.89 billion

Why is this a Bank of England issue? Well it has bought the corporate bonds of Maersk ignoring this issue.

The Danish shipping-and-oil conglomerate’s

Imagine having to explain to the UK taxpayer that you have lost their money supporting a Danish company in a policy you enacted after they had voted to break away from some European involvement?

 

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20 thoughts on “Is the Bank of England really giving us Forward Guidance for an interest-rate rise again?

  1. Well done Shaun.

    You are the sole beacon of sanity holding the boe accountable. Do you think the media are shifting towards your viewpoint, ever so slowly?

    As for interest rates. With the duplicitous boe look at what they do, not what they say.

    • Hi Chris

      A case of “And I’ve been putting out fire with gasoline, putting out fire
      with gasoline” to quote David Bowie? It would be in line with the Bank of England’s usual sense of timing and awareness though……

  2. Shaun, excellent annalysis but it’s raised my blood pressure especially when I think what these people earn for their ‘expertise’!

    Can you add some context to the extract from the BoE minutes – “The Committee voted unanimously in favour of all three propositions”? Were the three options to raise, lower and keep the same the bank rate?

    • Hi Doubting Dick

      Thanks and sorry about your blood pressure. As to the 3 propositions here they are.

      “The Governor invited the Committee to vote on the propositions that:
      Bank Rate be maintained at 0.25%;

      The Bank of England continue with the programme of sterling non-financial investment-grade corporate bond purchases totalling up to £10 billion, financed by the issuance of central bank reserves;

      The Bank of England maintain the stock of UK government bond purchases, financed by the issuance of central bank reserves, at £435 billion.”

      In this instance the latter was the most significant because a Gilt of ~£12 billion has matured this month and is being reinvested.

  3. It seems to me you are conflating communication of policy with the policy itself.

    As far as communication generally is concerned forward guidance is a joke and the general hauteur of the BOE is laughable; in my view they would do far better to say nothing ( as used to be the case); that would be a far more eloquent communication strategy .

    But following the maxim: don’t listen to what they say, look at what they do I’m afraid you are on much more shaky ground in your critique and this has to be the ultimate yardstick of judgement and indeed will be when the history is written.

    In 2011 they “looked through” inflation and were much derided for doing so but the fact is that inflation came down very sharply after this so were they so wrong in what they (didn’t) do? If they had put up interest rates (by a significant amount not baby steps) what would this have achieved with all the uncertain leads and lags of monetary policy? Not much of any good would be my judgement.

    As far as the current situation is concerned you say quite rightly that real wages are likely to fall and this is an implied criticism of the policy. But the fact that real wages will fall is in itself a corrective to the rise in inflation via its effect on aggregate demand. The “contraction” which you criticize is itself a corrective mechanism; it may be unfortunate but that doesn’t mean that in terms of monetary management it is wrong, a “mistake” as you describe it.

    It’s my belief that unless wages start to take off and start a spiral then they will also “look through” this episode and, loathe as I am to admit it and as much as I would like interest rates to rise, I cannot say that the BOE is wrong.

    • I think my problem, Bob, with the BoE is that they’ve painted themselves into a corner with ultra loose monetary policy. The emergency level is the new normal level, accompanied by high asset prices, high debt and a lot of looking through.

      It’s a bit like having to drive around at no more than 5 mph because the brakes are faulty, very sensible; but here we are 10 years on and nobody at the BoE seems to think the brakes still need fixing, but Kristin thinks things are going so well we could perhaps do 6 mph.

      • Like the Irishman asked the way to Killarney I would reply: I wouldn’t start from here – like you. But in getting “here” there have been trade offs, arguably the essence of economics; support GDP but get asset bubbles; it’s not all idiots at the helm all the time; choices have to be made.

        But we are where we are and the question is: what is the best policy and one looks not at mandates but what is sensible.

  4. Great blog as always, Shaun. Thank you for informing us about Kristin Forbes’s speech. Although it was delivered only a little more than a month before the Office of National Statistics could be switching the headline measure of inflation to CPIH, Forbes only discusses CPI inflation over the 2012 to 2020 period, and doesn’t even bother to speak about HPI inflation. Maybe Carney’s voice was ringing in her head, telling her the central bank does not target house prices. Nevertheless it is at least possible that the Chancellor of the Exchequer will choose to change the remit of the Bank of England so that it targets the CPIH next month as well. On what basis would one justify continuing to target the CPI if the CPIH is the headline inflation measure?
    Although no-one seems to be predicting a house price bust between now and 2020, it is interesting to see how differently the owner-occupied housing (OOH) component of CPIH and an OOH component based on net acquisitions (NA) would treat such a bust if it occurred. The ONS OOH(NA) quarterly series, flawed though it is, nonetheless peaks in 2008Q1 and troughs in 2009Q2 before it starts to rise again. The OOH component of the CPIH, by contrast, peaks in 2009Q1 and troughs in 2010H1. It is, in a sense, sensitive to the movement of housing prices, but it lags them in a way that makes it useless as the component of a macroprudential inflation measure.

    • Hi Andrew and thank you

      So far the Bank of England has been silent on the CPIH issue as my understanding is that it has been so preoccupied with Brexit that it has not really got around to the March changes. Not much time left….

      As to the Chancellor I suspect he has not focused on it. No doubt Nick Vaughan who used to be at HM Treasury and is now at the ONS has told them but how much has registered I am not sure. For now the fact that CPIH is not a national statistic would presumably block it being the inflation target, but as the James Bond film reminds us, never say never.

      One of the points I made to the national statistician was that OOH (NA) would have been useful in 2006/7/8 but CPIH would not.

    • Hi Eric

      Thank you that is rather good :). There was an argument at one of the Jackson Hole symposiums that such communication would have economic effects in the real economy as people and businesses adjusted their behaviour. I argued from the beginning that this depended on people having faith in central bankers at a time when it was in short supply. With his “unreliable boyfriend” style issues it was in even shorter supply for Governor Carney at the time of your link and of course probably negative by now.

      • Yes Shaun, How many desperate savers voted “leave” in the hope that interest rates would rise? Enough to make a difference to the result? Or were Carney’s unreliable boyfriend musings ignored? Who knows!

  5. If you’re going to do forward guidance at least do it right. I’ve seen two such wonderful examples in recent days, one by PWC suggesting the UK will be the fastest growing G7 economy until 2050 and another by former BOE monetary policy committee member David Miles saying house prices in the UK will outstrip wages for the next 50 years. People making those sorts of projections will be retired or dead before they have to defend their useless models (if anyone even remembers the predictions being made all those years before). Maybe Kristen and her friends should stick to such forecasts.

    • Hi redshift and welcome to my corner of the web

      I think we can file both of those predictions as being even beyond the “long grass” of Sir Humphrey Appleby of Yes Minister. For a start will those making the predictions even be alive to be critiqued or corrected at the end of the forecast period?

  6. No, because May and Hammond (not them from Top Gear!) are scared to death of house prices falling, especially as they might go for an early election. Key blocks of voters are not that concerned about austerity (they can always blame immigrants), but don’t mess with their easy money.

    As for Maersk, having worked briefly for them, all i can say is HAHAHAHAHAHAHAHAHAHA!

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