Difficulties of future speak
Mark Carney, the bright new governor of the Bank of England, is expected to do something to help the UK economy. When he takes over the helm in July his main monetary innovation may be imitation. Apeing the U.S. Federal Reserve, Carney may adopt a policy of issuing “forward guidance” designed to talk down bond yields. Carney may well find himself swimming against a bond bear tide, and find reluctance by the BoE’s Monetary Policy Committee to print more money.
Forward guidance on policy is a fashionable idea popularised by the Fed’s Ben Bernanke. The Fed became more explicit on its future policy thoughts in August 2011 when it anticipated “exceptionally low levels for the federal funds rate at least through mid-2013”. That was news to the private sector and helped to shift long-term interest rates down by between one and two-tenths of a percentage point. These shifts, according to John C. Williams, the San Francisco Fed governor, were “big drops” that would normally have required a cut in the Fed funds rate of as much as a full percentage point.
In the UK, Carney may well want to do something similar. But the global mood is shifting against safe-haven government bonds. The recovery in the U.S. and the possibility the Fed will rein in its money printing and bond purchases have driven up 10-year Treasury yields by 50 basis points in the past month. Meanwhile, the yield on 10-year UK government bonds has climbed to 2 percent from just 1.6 percent a month ago.
In the UK both economic fundamentals and BoE policy are critical factors. UK growth came out at 0.3 percent in the first quarter, causing 2013 growth forecasts to be raised tentatively. And the BoE’s Monetary Policy Committee has been voting 6-3 against more quantitative easing – with outgoing boss, Mervyn King, among the outgunned minority. Without the BoE buying gilts and with the government planning some 155 billion pounds in gilt issuance in the current fiscal year, the pressure on yields looks to be on the upside.
For the policy of offering future guidance to be effective in reducing yields, Carney may also have to kick an apparently reluctant MPC into QE and mopping up of gilt issuance again. That won’t be easy unless UK data, soft in the past few weeks, keeps disappointing in the summer, bringing renewed pessimism. Words can help but in the markets money really talks.