“Everyone now seems to be doing ‘forward guidance’,” says Jeremy Warner on Telegraph.co.uk. The US Federal Reserve started it. Bank of England (BOE) governor Mark Carney used the term at his first Bank meeting last week. The European Central Bank (ECB) has also “caught the habit”. But what is it?
It means indicating how long and under what conditions interest rates are likely to remain low, or money will continue to be printed. It is one of the unusual measures central banks have resorted to since the crisis, and the idea is to boost confidence and activity by reassuring investors, consumers and businesses that loose monetary policy will endure until the economy is strong enough to cope without it.
When will interest rates rise?
The Fed has said that it will keep its short-term, benchmark interest rate near zero until the unemployment rate is down to 6.5%. And it is set to slow the pace of its money-printing programme but won’t stop until the labour market shows “substantial progress”. That was later defined as 7%.
The ECB president, Mario Draghi, having declared just three months ago that “we do not pre-commit on interest rates”, last week said he “expects the key ECB interest rates to remain at present or lower levels for an extended period of time”. In Britain, Carney said that the rise in long-term, market interest rates “was not warranted by the recent developments in the domestic economy”. In other words, the markets have got it wrong and the Bank’s benchmark, short-term interest rate will stay low for some time. Next month he is expected to propose a formal threshold for when the Bank rate should rise – when GDP growth reaches a certain level, perhaps.
The ECB and Carney had no choice, says Warner. Now that the Fed has started talking about tightening, US Treasury yields have started to creep up. As American debt sets the tone for other bond markets, long-term interest rates elsewhere have risen too. But “it’s plainly far too early for Europe to tolerate any monetary tightening”.
British balance sheets are also in no fit state to absorb a rise in interest rates, “or at least not without killing the growth fairy stone dead”. Thanks to Draghi and Carney, European markets “breathed a collective sigh of relief”, said Alister Gaines of CDC Wealth Management.
Mollycoddling the markets
Here we go again, says Economist.com’s Buttonwood blog. Markets have become addicted to liquidity injections and panicked last month after the Fed started talking about withdrawing stimulus. But “if one central bank isn’t handing out goodies, another will be”. This time the ECB and the BOE placated hyped-upinvestors. “It is a nice irony that titans of fund management, who consider themselves robust champions of the free-market system, are so dependent on handouts from the monetary authorities.”
It is also ironic, for that matter, that “investors who otherwise believe in free markets” accept central bankers setting the supply and price of money, as Tim Price of PFP Wealth Management points out – and, via forward guidance, attempting to set the price of money far into the future. For all the column inches lavished on central bankers and their pronouncements, you’d think they were good at what they do.
Yet in the past 20 years, the West has experienced continual bubbles, culminating in the credit binge and bust. Soon, as we pointed out recently, central bankers will attempt to wind down unprecedented money printing without causing shocks. Yet banks and investors have loaded up on overpriced assets in recent years and a sharp sell-off in US bond markets could choke off America’s recovery. Given central banks’ record, investors should keep their tin hats handy.
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