The threat to quantitative easing – or QE – is like a nuclear deterrent. If rates are forced up by the markets, we will use QE, suggests the Bank of England, and therefore there is no need for it, as markets price in what might happen if they don’t heed the bank’s words. That is the theory. It is as if Mark Carney bestrides the banking stage, with his finger always near the red button marked QE, and as a result the markets dare not release their venom, for fear that they will be caught out by detonation. The reaility seems quite different, and yesterday Mark Carney had another go; putting on his poker face and staring at the markets: “Go ahead,” he seemed to be saying, “make my day.” Alas, the markets are still not buying it.
The markets have been pushing up yields. The yield on UK government ten year bonds has risen from a low of around 1.5 per cent a year ago, to 2.8 per cent at the time of writing. The Bank of England says rates are going to stay low until 2016, but the markets are far from convinced.
It is presented as bad news but actually it may be quite the opposite. The Bank of England says rates may rise once unemployment falls to 7 per cent, providing inflation does not show signs of rising sharply. The markets are saying they think this will happen in 2015; the Bank of England is saying 2016. So to try to convince the markets, Mark Carney has to try to talk down the prospects of the UK recovery without – and get this for an impossible mission – dampening confidence.
Yesterday Mark Carney spoke. In fact he was speaking at the East Midlands Conference Centre. So that’s quite a journey for Mr Carney, from Canada to the East Midlands Conference Centre – whatever next, the Andromeda galaxy perhaps?
Give the new governor at the Bank of England credit, he was transparency itself. He said: “Our forward guidance provides you with certainty that interest rates will not rise too soon. Exactly how long they stay low will depend on the progress of the recovery and in particular how quickly unemployment comes down. What matters is that rates won’t go up until jobs and incomes are really growing.” He also said: “We will have to see the rate of unemployment, currently 7.8 per cent, fall at least to a threshold of 7 per cent before even beginning to consider whether to raise Bank Rates.” Note that: even considering raising rates.
He then went at great lengths to spell it out: getting unemployment down to 7 per cent will be tough. So why then are markets pushing up rates? Mr Carney said one possibility is that: “Markets think that unemployment will come down to 7 per cent more quickly than we do. Since the aim of our policy is to secure recovery as quickly as possible, that would be welcome. But policy is built not on hope, but on expectation. And we estimate there is only a 1 in 3 chance of unemployment coming down that quickly.”
So note that: he is saying there is a one in three chance that rates will rise before 2016.
Finally, he made a reference to the US. When the Fed revealed plans to start reducing QE soon, many assumed the Bank of England would follow – leading to yields on bonds rising, and fast. You may be interested to know, that for the last three months, the yield on US government bonds has been higher than the UK equivalent. This changed this week, however, as markets rushed to safety over fears of a Syrian conflict escalating. On the subject of US and UK rates, Mr Carney said: “While much has been made of the special relationship between the US and UK, it is not so special that the possibility of a reduction in the pace of additional stimulus in the US warrants a current reduction in the degree of monetary stimulus in the UK.”
So it’s all pretty clear. The Bank of England has no plan to up rates soon. The markets responded by pushing up market rates. Soon after Mr Carney sat down yesterday, the yields on UK government bonds rose.
The markets are not buying it. Carney may yet be forced to push the ‘more QE button’ after all – it is just that the decision is not just his. Carney has a politburo – or a Monetary Policy Committee – that must vote to extend QE. And the markets don’t believe Carney’s colleagues will allow him to press the button.
© Investment & Business News 2013