We’ve always maintained that new Bank of England governor Mark Carney was hired by George Osborne to do the job of pumping up the UK economy as quickly as possible before the election.
So he had to make an impact on h
is first day up in front of the public. He didn’t disappoint.
Sterling collapsed following his comments after his first Monetary Policy Committee meeting. The stock market surged.
So what did he say? And what does it mean for your money?
Markets are wrong, says new Bank of England boss
I apologise in advance. I’m sure you’re sick of hearing about quantitative easing (QE). You’re probably already fed up with the ‘taper’ and the bad puns it has spawned.
But you’re going to have to get used to yet another central banking buzzword: ‘forward guidance’.
This awful language is designed to make you switch off. A headline that reads: “BoE gives FG on QE” is not a story anyone wants to read.
One that instead says: “Central bank tells markets exactly what the price of everything should be for the next few years” might make you start thinking.
It might make you start wondering why we have markets at all, if it all boils down to a handful of unelected guys (and they are mainly guys) deciding what the price of everything should be.
Because this is what forward guidance boils down to.
Let’s have a quick recap. The original point of an ‘independent’ central bank in Britain was to stop inflation from taking off. The political cycle meant that politicians couldn’t be trusted with control over interest rates. They’d always be tempted to drop them before an election, so artificially overheating the economy.
So the Bank was given charge of interest rates instead. It would keep inflation under control, regardless of what politicians wanted.
Now, the Bank has always done a bad job. Before the credit crisis kicked off, it ignored a rampant credit bubble. Apart from a few warnings on house prices from Mervyn King, it did nothing. In fact, it actively encouraged the bubble.
Its excuse was that it was tightly focused on its Consumer Prices Index (CPI) target. But the real truth is – no one wants to burst a bubble. Particularly not if they want to keep their job.
Then in 2007/2008, the credit bubble burst. Since then, inflation has risen above target many times. The Bank has simply ignored it. Whatever it’s targeting, it’s clearly not CPI.
So what was so dramatic about Carney’s actions yesterday? One way that central banks keep markets on their toes is by reacting to economic data. If it improves, markets start to prepare for higher interest rates, and vice versa.
But yesterday, Carney said that the market’s expectations for rates to start rising in mid-2015 “were unwarranted”. That’s ‘forward guidance’.
Next month, he’s likely to give more details on exactly what it would take to drive rates higher – growth at a certain level, maybe. But effectively, Carney is saying: “You guys have got your predictions wrong. Interest rates will stay at current levels, no matter what happens to inflation, or growth. So re-adjust your prices.”
One reason Mark Carney should be worried
Stocks soared on the news that rates would stay lower for longer. And sterling plunged for the same reason.
But – and here’s what should be a little worrying for Carney – bond markets weren’t quite as impressed. As Chris Giles and Robin Wigglesworth note in the FT: “bond and interest rate markets were much less impressed by the BoE’s words than currencies and equities.”
The ten-year gilt yield eased from 2.42% to 2.38% (ie the price rose a bit). That’s “little more than a normal day’s movement”. Bond markets are often known viewed as the ‘smart’ money. In this case, it may be true.
Carney’s promise to keep interest rates low might mean more QE being pumped into markets. But it’s also likely to mean more inflation. And higher inflation is bad news for bonds. Why would you want to hold a fixed-income UK gilt if inflation is going to be eating away at your returns?
With Britain still hugely indebted, the last thing we need is rising government bond yields. Higher rates aren’t good news for the housing market in the longer run either. So if Carney starts to have a problem keeping a lid on rates, we could all be in trouble.
What this means for your money
What does it all mean? Well, this is clearly the way forward for central banks. European Central Bank boss Mario Draghi did the same thing as Carney at his meeting, which helped boost eurozone stocks and hammered the euro. That’s good news for the cheap eurozone stocks we’ve been suggesting you buy.
The difference in the eurozone however, is that monetary policy has been relatively tight for some time, so Europe has more room to loosen policy without spurring inflation than we do.
As for the US, Ben Bernanke probably feels a little left out. With every other central bank promising lower rates, he might want to do more. The next big piece of data comes out later today (at 1:30pm our time). US jobless claims are expected to hit 165,000 – a big deviation from that could change the Fed’s plans.
Higher claims would mean more QE, a weaker dollar, and stronger stock markets. Lower claims would mean less QE, a stronger dollar, and weaker stock markets.
But the one I’ll be keeping a close eye on is US bond yields. Because it seems to me that the tectonic plates have now shifted, and we’re at the very beginning of a bond bear market. If that’s the case, then it’s going to be much harder for central bankers – whatever they do – to prevent interest rates from rising.
In fact, their best bet might be to leave well alone. MoneyWeek regular James Ferguson looked more closely at what this means in last week’s issue of MoneyWeek magazine. If you’re not already a subscriber, you can get your first three issues free here.
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