Comment: One step forward, two steps back

Carney: where did he get his crystal ball? Picture: Getty
Carney: where did he get his crystal ball? Picture: Getty
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WHEN it comes to final farewells, a short service at the graveside is best. And how apt this would be for the Bank of England’s “Forward Guidance”. It needs to be brief – particularly after such a long, lingering illness.

A gentle lowering of the casket, the scattering of a few forget-me-nots from the Garden of Remembrance and a succinct address – though preferably not from governor Mark Carney. Then off to the pub for a full-strength single malt with the caveat “Best after 2016” on the label.

It seemed only yesterday, so familiar have Carney’s interest rate rise signals become, that UK businesses, house buyers and investors were put on alert for a rise in interest rates – widely interpreted to be this side of Christmas, or early in the New Year at the latest.

Now the Bank has signalled that interest rates could be held at their record low well into next year as global uncertainties weigh on the UK’s recovery.

Some analysts now suggest we may not see a rise in rates until well into 2017. This would take the temporary, “emergency” period of 0.5 per cent interest rates into its ninth year.

What a time of trial this has been for the Bank of England governor and his much-vaunted policy of “Forward Guidance”. This was introduced as the Bank’s new flagship policy more than two years ago, in August 2013. It was designed to give us a clearer indication of the Bank’s thinking on interest rates six months or so ahead rather than keeping us on tenterhooks with each monthly meeting of the interest rate-setting MPC.

I was sceptical about it then and my doubts have risen with every guidance statement. From whence had Carney acquired this elusive crystal ball to see into the future? How could he be so confident of market conditions so far ahead?

Sure enough, the forecasts were changed and changed about – from a statement in February 2014 of “no rate rise until next year” to a pronouncement in July that a rate rise would “come into sharp relief around the turn of the year” to last week’s Inflation Report assessment that inflation would remain below 1 per cent until the fourth quarter of 2016, well below the Bank’s 2 per cent target.

Little wonder that so many are befuddled by “Forward Guidance” and no longer trust it. To be fair to Carney, he did not claim to have developed supernatural powers but rather set out to clarify the Bank’s interest rate thinking. He could not know how events in China this year would impact on global growth prospects – the Bank’s forecast here lowered to 3 per cent from 3.2 per cent three months ago – and the impact on global commodity prices (driving them lower).

Indeed, the bigger question is not so much how events can change central bank expectations, but why the UK economy has not responded more robustly to rock-bottom interest rates.

For decades the moans from business lobbies have centred on inflation and interest rates. If only raw material and input costs would stop rising… if only interest rates were not so high we would invest more… Inflation and high money costs were seen as the two greatest barriers to investment and expansion.

Yet we have now had quiescent inflation and ultra-low interest rates for an extended period, but a persistent poor productivity record and only a modest investment take-off.

It may be that business does not trust the financial landscape – particularly after the 2007-09 global crisis and recession – and does not want to be caught out again as banks, investors and customers slam on the brakes. We understate the period of convalescence required after such traumas, just as we underestimate the period of bereavement after a loss. Even so, seven years would be pushing it by historical standards.

It may be that we are less entrepreneurial than we used to be. Or that the planning stages between initial investment idea and commencement of work are much more extensive and prolonged.

There are also formidable barriers to quick response. House building is a good example. It is all very well for the government to issue impressive-sounding housing targets. But we have to crank our way through development protocols, planning procedures, council building policies and regimes of constant consultation.

Even after all this – perhaps because of it – building completions can be snared by supply constraints down the line. An example before me is a modest building project held up because the company that supplies the windows (first inquiry order in September) has a backlog of orders and cannot deliver much before February. Suppliers in Eastern Europe are blamed. Extend that across other critical material and service suppliers and you see why acceleration to final result can be so slow.

The one consolation for the housebuilders and the house furnishing industry is that the latest push-back of rate rise expectations until well into next year should give a fillip to mortgage demand, house sales and prices.

Last week, ahead of the latest Bank pronouncement, the Halifax reported house prices rose by a robust 1.1 per cent month on month in October, taking the year-on-year increase to 9.7 per cent in the three months to October. But the expectation of ultra-low mortgage rates for the foreseeable future should add to demand and give price pressures another upward twist.

Elsewhere, the Bank’s latest guidance should be good news for the domestic economy, giving consumers some assurance of stability on borrowing costs and helping to boost business confidence. But the reasons for the deferral of rate change expectations should not be ignored – the slowdown in global growth.

Arguably the most important consequence of the Bank’s latest guidance is the effect on the sterling exchange rate. The pound fell sharply last Thursday as the implications of the Bank’s latest signals on interest rates sank in. But the pound is still too high, causing serious problems for exporters and adding to an already colossal balance of payments deficit.

Markets can be slow to react to a persistent trade deficit until a catalyst comes along and the currency suddenly comes under pressure. It is hard to see such a catalyst in the immediate future. But then, that is the problem with forecasting, as the Bank has – once again – discovered. «