The British economy has been basically stagnant for the past three years, failing to achieve the kind of moderate growth that the United States and Canada have managed. Now the Bank of England is looking to do something about it. Too bad markets aren't quite buying it.
Taking a page from the strategy that the Federal Reserve has used under Ben Bernanke, the Bank of England's new governor, Mark Carney on Wednesday laid out its strategy for "forward guidance," of communicating its future intentions more clearly. Here's the long version. And here's the short version: We're going to keep interest rates very low so long as the UK unemployment rate remains above 7 percent (it is now 7.8 percent), so long as we don't expect inflation to rise above 2.5 percent in the medium-term (which is a bit more than the bank's usual 2 percent inflation target) and we don't think there are problematic financial bubbles being created by our low interest rate policies.
The Bank of England's policy committee expects the jobless rate to stay that high through about the third quarter of 2016, and for inflation trends to remain contained, which means investors can plausibly interpret the guidance as a promise from the central bank to keep its foot on the accelerator of UK growth for another three years. It's quite similar to the Bernanke Fed's "thresholds," indicating it will keep low rates in place until the U.S. unemployment rate drops below 6.5 percent or U.S. inflation is set to exceed 2.5 percent.
This is the policy innovation the British government was looking for when it hired Mark Carney, the governor of the Bank of Canada, to run the UK central bank. Carney was ahead of the curve in using these unconventional communications strategies to try to support the economy in Canada, using the strategy first in April 2009, and now has come full circle.
The only problem? Markets aren't, on day one at least, persuaded. If the new communications were successful in assuring markets that the Bank of England will do whatever it takes to get the economy on track, you would expect for longer-term interest rates on gilts, or UK government bonds, to fall, for the stock market to rise, and for the pound to fall on currency markets. Instead, the 10-year gilt rate is up (if only slightly), the British stock market is down, and the pound is up 0.76 percent against the dollar.
Part of this is because the action was well telegraphed; because Carney had made clear something in this vein was coming in the announcement following the bank's early July meeting, it was no surprise.
Indeed, it was, if anything, less definitive than markets were expecting. It might have coaxed a warmer response in the financial markets if the unemployment threshold was lower (implying low rates for longer), or if the policy didn't include so much hand-wringing about the risks of financial stability, or if the Bank didn't display so much skittishness about inflation rising above 2.5 percent.
In other words, what matters in the forward guidance game is not just whether you do it. It matters quite a lot what you're committing too.