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Is the Bank of England Just Making It Up as It Goes?

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The Bank of England is getting a knack for sharp screeching U-turns, not ideal when governor Mark Carney's beloved "forward guidance" plan over the path of interest rates is meant to be clear and credible.

Carney's first attempt at forward guidance had to be dumped after six months, as the plan to have Bank officials only start to consider raising interest rates once the unemployment rate hit 7% was thrown off course as the unemployment rate looked to be falling much faster than they anticipated.

Not that Carney would admit the plan had failed, even if unemployment ended up hitting the 7% target two years earlier than planned. Instead, the Bank's guidance on how they will increase interest rates was "evolving".

What did he offer instead? Rather than dumping the plan outright, Carney proudly revealed something more "nuanced".

Out went the "well understood" failure of the 7% unemployment marker, and in came 18 separate economic indicators charting the Bank's effort to close the UK's so-called "output gap" of slack in the economy.

This new blizzard of information has been already widely mocked as "fuzzy guidance". Even the Bank had previously poured scorn on the idea of focussing interest rate policy on the output gap, warning that it "does not perform well from a data or communications point of view".

The markets still have followed Carney's "fuzzy" guidance, taking the nod from the Bank that it expected to finally start raising interest rates in 2015, roughly in time for next spring. Rate-setters on the Bank's Monetary Policy Committee made that clear too, with Martin Weale saying as recently as February that it was the "most likely" path for interest rates.

And now Carney has performed his most daring U-turn yet, seeming to express astonishment that the markets actually believed him and the Bank's forward guidance.

Carney used his Mansion House speech last week to tear up his flagship plan once more, teasingly warning that the Bank could actually hike interest rates "sooner than markets currently expect" given the speed of the economic recovery.

On top of that, the latest minutes from the Bank's MPC meeting this month show that the rate-setters find the market's expectation that they'll do as they planned and raise interest rates next spring "somewhat surprising". They were rather bemused that the financial markets only gave the chance of an interest rate hike this year a "low" probability.

In response to the Bank's sudden bewilderment that anyone would think that they actually would raise the cost of borrowing when they said they would, the markets now expect the first rate to rise by the end of the year.

Carney first introduced forward guidance as a way to make the Bank's thinking more transparent and understandable to the public, allowing people to be reassured tha that the Bank was not going to suddenly spring an interest hike upon them.

The new plan intended to be an improvement from his predecessor Mervyn King, who assessed the state of the economy on a month-by-month basis.

Carney is doing just that, now his forward guidance has fallen apart, but will not admit it. The Bank is now reacting to the twists and turns of the economic recovery as it comes, lurching in different directions as to when it may have to hike rates.

At least the Bank is getting some new blood, as Nemat 'Minouche' Shafik and Dr Kristin Forbes join the MPC later this year. Let's hope the new recruits help steady the ship.

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