Governor prepares to usher in era of 'forward guidance'

Thumb_richard-edgar

The sun is shining, shoppers are buying, factories are pumping out goods. The economic news just gets better and better - on Wednesday it's likely the Bank of England will lift its forecast for growth in the economy this year and next.

And that's a problem. Most people recognise that when conditions are good and demand rises then prices also head upwards. At that stage the Bank is obliged to raise interest rates to dampen demand (and thus inflation).

Shoppers in central London during the warm weather
Shoppers in central London during the warm weather Credit: Press Association

It's this expectation of higher-rates-to-come which the Governor of the Bank of England, Mark Carney, thinks is putting off households and businesses from borrowing - and using that money to spend.

But as rain follows sunshine, the economy is not yet on a sure footing and could yet be knocked off course, perhaps by a deterioration in the eurozone. Raising interest rates too soon could wash away any nascent recovery in a flash.

So the governor is expected to unveil some form of "guidance" tomorrow which will pledge to keep rates low until the economy is convincingly robust again - even if inflation is higher than he is supposed to allow.

Mark Carney, Governor of the Bank of England
Mark Carney, Governor of the Bank of England Credit: Press Association

The big conundrum is how to get the message across. In order to be effective it has to be credible; the point, after all, is to give the country confidence that taking on a loan at record low interest rates now to fund a big purchase won't mean you risk being stung imminently by higher rates.

But inflation is a wild, unpredictable beast, powered not just by domestic demand but also factors abroad (like oil prices) and government policies (the policy of student tuition fees has pushed overall inflation higher). It is corrosive, eating away at spending power and the Bank has spent many years "anchoring" our expectations that inflation is largely under control.

It (and the governor) will not want to throw that away by allowing prices to rise apace because of a rash promise not to raise interest rates.

The Bank has held interest rates at their record low of 0.5% since March 2009
The Bank has held interest rates at their record low of 0.5% since March 2009 Credit: Press Association

So we are likely to get a very careful worded explanation tomorrow which promises to keep rates low for a certain fixed time or until an economic measure like unemployment falls to a certain level... Or, maybe just a vague promise to keep them low until the economy is, in the Bank's view, growing sustainably. All the while, there will be a get-out that while inflation might rise in the near term, it must, by the Bank's reckoning, be expected to fall in the medium term.

Snappy, isn't it? Each of the options has advantages and disadvantages but the key measure to my mind is whether the message is comprehensible to the very people the governor wants to reach - those about to make a decision to borrow and spend... or not.

Make the pledge too simple and it risks tying the Bank's collective hands. Make it too complex and we'll all need to be monitoring economic data like City economists, trying to second-guess the governor's next move. We Brits are keen amateur weather-watchers, but would we make good economic forecasters?

Dr Carney, over to you.