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Rates lower for longer – now Carney’s on board

We have long held the view that central bank interest rates will stay low for several years - and new Bank of England (BoE) Governor Mark Carney agrees.

Carney has given added clarity to the Bank’s monetary policy. It initially appeared positive for growth and negative for savers and sterling, but on closer reflection it’s a high-stakes gamble on confidence and policy-credibility that should work.

Carney, who is a very polished ex-investment banker, presented a policy that offers the prospect of low interest rates for some time but, of course, doesn’t guarantee them. It leaves open the possibility of disappointment and policy error, but is more pro-growth and less sterling-negative than the markets initially thought.

To satisfy both those looking for lower rates and the avoidance of a credit binge, Governor Carney introduced a more clearly defined strategy. As announced, ‘forward guidance’ determines that interest rates will stay unchanged for as long as it takes the Bank and its allies in the Treasury to deliver unemployment of 7%.

Currently, the UK unemployment count is 7.8% with an average of 6.1% over the period 1995-2005 and we have long held the view that unemployment is a better measure of economic performance than GDP (activity).

Consumer price inflation is currently 2.9% relative to its mandated range of 1-3%. The Bank is required to deliver inflation in that range by order of the UK parliament and has tended to argue that its medium-term forecasts foresee inflation returning to the centre of that range.

But the low interest rate policy comes with three caveats or “knockouts” as the BoE has termed them. They are: 2.5% inflation is breached over 18-24 months; the public starts to expect ever higher inflation over the medium term; and policy looks set to create financial instability.

The question for investors is whether the BoE’s massive monetary stimulus, and accompanying fiscal measures that make it less comfortable to remain out of work, induce a sustainable long-term recovery in time, before inflation starts to move further above the BoE’s charter rather than returning to it.

Essentially, the BoE is betting on two things. First, that the public is convinced and doesn’t bid up prices and contracts. Second, that by projecting a heavily-qualified no-change in UK rates, while the world expects US rates to rise, the BoE will simultaneously be able to hold UK rates below US rates and retain a reputation of prudence that stops the pound for enduring heavy selling.

We continue to back our theory that it will be lower rates for longer and we believe that, despite Carney’s caveats, his guidance is more clear cut than the hawkish sceptics believe.

Article published in Coutts Investor Insights blog.

This was posted in Bdaily's Members' News section by Alan Higgins .