What is the point of forward guidance? The Fed started the trend, even the ECB has abandoned its own 'we never pre-commit' mantra and gone for it, and now the Old Lady hasn't been able to resist the peer group pressure to join the party.
Personally, I just can't see what forward guidance brings to the table, above and beyond the more subtle messages about easing or tightening biases from central bankers that we have been used to deciphering for decades. Don't get me wrong; I'm not advocating a return the pre-Greenspan era in the 80's when the Fed didn't actually announce a Fed Funds target; we just had to guess where they wanted it to be from the amount of reserves they left in the system. The 1994 bond market rout was certainly started by a surprise Fed rate hike, and its severity was undoubtedly exacerbated by the suddenness of the volte face in policy, which did nobody any good.
The Bank of England's decision to adopt 'outcome-contingent' guidance, as opposed to the 'time-related' alternative, was at least a wise choice; if nothing else, with respect to the future prospects for its own credibility.
At least under this regime, the need to raise rates rather sooner than is currently implied by the forecasts within the Bank's August Inflation report will represent only a minor embarrassment, and with a little luck will be delivered in the context of good economic news -and let's face it, the Bank is used to forecasting embarrassments!
The nightmare scenario for the Bank, and for us all, is that policy has to be tightened because one or other of the 'knock-outs' has been triggered before unemployment has fallen meaningfully. Imagine a world, 12 or 18 month's hence, where either 'knock-out' 1 or 2 is triggered, but unemployment is stuck stubbornly at 7.2%, say.
Given what's happening in the housing market, and the prospects for acceleration thereof following this guidance, and the UK economy's propensity to exhibit high inflation, I see a real danger that knock-out 2, (medium-term inflation expectations become unanchored), is the problem. If one was cynical, with respect to the first 'knock-out', one might say a) it implies that the Bank's inflation target has been surreptitiously raised, if not to 2.5%, then certainly some way above 2% and b) since the knock-out's breach is dependent on the BOE's own forecasts, there may be a conflict of interest there. It will now be vital for the markets to see if these decisions were unanimous, which we will find out on 14th August, when the meeting minutes are released. Absence of unanimity will undermine the whole message and probably increase fears of earlier tightening.
On the other hand, given the 'productivity puzzle', (in this recession, productivity has dropped, and unemployment has risen less than one might normally expect), the stage seems set for productivity to rise, at the expense of employment, especially as employers become more confident and commit to long-delayed capital investment in new, more efficient plant and machinery.
But, I hear you say, even if it doesn't have any discernible utility, what actual damage can forward guidance inflict on the economy? Well, possibly quite a bit; three different points spring to mind.
On the one hand, a few weeks ago I highlighted in this blog the dangers of inflicting psychological damage upon people and businesses by telling them effectively to ignore the good economic headlines that are increasingly appearing in the newspapers-the Bank of England doesn't believe a word of it, and they should know.
On the other hand, if either inflation 'knock-out' is triggered within the 12 to 18 months time horizon I mentioned above, that is a lot sooner than the date at which the Bank of England's own forecasts expect unemployment to hit 7%, i.e. mid-2016, (and Carney assures us 7% is only a 'way station' anyway, not a 'trigger' for higher rates), and the danger here is that individuals and businesses are fooled into taking on more and more debt, comforted by the Bank's prediction that rates will stay where they are for almost another 3 years, at a minimum-and the UK can already hardly be characterised as a country with low private debt. If rates do have to rise much sooner than this, then loan delinquency could sky rocket.
The trouble with the 'low for longer' promise is that it can encourage both the mis-pricing of assets and tempt investors into projects which just don't 'wash their faces' if rates rise.
The third, and admittedly more arcane, danger is that one or more of the possible embarrassing outcomes for forward guidance ultimately destroys the credibility of our central bank.Suggest a correction