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Vizeum: Forward guidance and the BoE – What does it mean?

Some of you may be aware that on Wednesday the new governor of the Bank of England made a pretty ground breaking statement. In basic terms he informed the country that interest rates are to remain at their current low level (0.5%) for the short term.

What does the “short term” mean?  Mr Carney has primarily linked interest rate movement to employment stats.  The “rule” is that when unemployment hits 7% (currently at 7.8%) then the bank will review the interest rate levels.  There are some additional caveats that could trump this “rule” with the major one being that if inflation rates are predicted to be above 2.5% consistently over a 2 year period the promise would also be reviewed.  Bearing in mind that inflation over the last few years has averaged significantly higher than this target the actual “rule” could be seen as a straw man.  Factor in the fact that we’re only talking about 750k new jobs, aligned to the very recent furore over 0 hour contracts and the aim of the policy becomes very questionable.

Why has this been done then?  Its aim is to provide companies and consumers stability.  If as a business you are about to embark on investment then you can feel comfortable in the knowledge that your repayments will stay stable over the next few years.  If you are a consumer with a mortgage linked to the base rate you will also experience this.  Mr Carney hopes that this stability in consumer and commercial finances will allow people to finally invest or spend  on goods and services and engineer economic growth.

The Vizeum viewpoint

Increased stability and potential consumer spending is a great thing.  This is likely to stimulate the housing market as mortgages become cheaper and more accessible leading to increased investment in home furnishings, construction , white, black and consumer goods, especially as the benefit of saving is hit by this “rule”, why would you save?  That’s the economic rational viewpoint and the theoretical aim.  However  Humans aren’t driven by rational thought and it’s the emotional that holds sway, with nearly 5 years of austerity and several more to go this is going to be a slow burn as consumers begin to disengage with this established mindset  , it’s more of a PR stunt for the BoE and Mr Carney in his new role.  All this in concert with the tentative green shoots already been witnessed and in reality it’s unlikely we’ll ever be able to really define the benefit of this new “rule”.