Bank of England governor Mark Carney took almost everyone by surprise last week when he stated that UK interest rates could rise earlier than markets think.
Up to now, he has used ‘forward guidance’ – a policy innovation introduced with much fanfare last August – to signal that rates would remain lower than normal for longer than usual, given the need for a period of repair in the economy. Indeed, this was still his message only a month ago, when presenting the Bank’s latest Inflation Report forecasts.
So what has changed in the intervening month? Three possible explanations spring to mind: the pace of recovery; the effectiveness of other policies for slowing the economy; and finally, a substantial shift in the debate within the Monetary Policy Committee (MPC).
The first explanation is not convincing. Other than some stronger-than-expected labour market figures – and even there, pay pressures remain strikingly subdued – the data have come in broadly as expected.
As for the second, it is possible that the governor is getting cold feet on macro-prudential policy tools. Carney did admit in last week’s speech that macro-prudential policies could not be used as a substitute for interest-rate increases; previously, he may have at least given the impression that they could. As their introduction draws near, Carney may have been reading up on the track record of macro-prudential tools, which would give even their most ardent supporter some pause for thought (a recent study from the Bank for International Settlements found that their effectiveness has been patchy at best).
As for the MPC debate, until we see the minutes on Wednesday, this must be the strongest candidate to explain the change in messaging from the Governor on the timing of that first rate rise. Following his speech last week, markets responded by bringing forward their expectations on the timing of that first rate rise to late this year; if we find that one or more MPC members was seriously contemplating a vote in favour of higher rates this month, markets could bring that expectation forward further still.
Carney, along with other MPC members, has stated repeatedly that it is not the timing of the first rate rise that matters for the economy, but the medium-term path of rates. In one sense this is a fair point, and his (and the MPC’s) message has so far not changed on that medium-term path – rates are set to remain lower than pre-crisis ‘norms’ over the next few years, as the economy continues its slow process of repair. We do not expect any change in this message in the MPC’s minutes.
In another sense, however, it seems a little disingenuous to play down the timing issue. Rates have been unchanged now for over five years; it is only natural that markets - and savers, and borrowers - should focus on when a break-out from that long-standing pattern is likely to take place. Furthermore, forward guidance was designed not only to dampen expectations of how high rates might rise in the medium term, but also to underline the message that the first increase would not come for a long time – initially, it is worth remembering, in the second half of 2016. If rates are to start rising as much as two years sooner than the governor was signalling only last summer, it should not come as a surprise to the MPC that this timing issue remains a matter of interest.
Lucy O’Carroll is chief economist – investment solutions at Aberdeen Asset Management.