The Enterprise Britain Guide to ‘Forward Guidance

The financial world is trying to get to grips with a new economic concept: ‘Forward Guidance’.

The Governor of the Bank of England, Mark Carney, introduced the concept into Canada in the Spring of 2009. The evidence as to its effectiveness is mixed. In particular it has not stabilised rates in the fixed income market.

The objective of ‘Forward Guidance’, as enacted by the Governor, is to provide the markets with certainty. In separate announcements, The Bank and the European Central Bank displayed dovish strategies by promising that interest rates will remain low for the foreseeable future. The advantages are clear. The consequences are the problem:

a) The pound has fallen against all major currencies except the Euro. Against the dollar it has fallen to below $1.50 making exports more attractive and imports increasingly expensive.

b) In the United States, the Federal Reserve is moving in an opposite direction by reducing its Quantitative Easing (“QE”) programme. This had consequences in the Far East where markets fell and Chinese liquidity came into question, albeit, some commentators suggest, coincidentally.

c) The question being asked is whether ‘Forward Guidance’ has the fire power to influence interest rates independent of other influences. If Israel declares war on Iran and world oil prices shoot up the inflationary consequences for the United Kingdom might force the Monetary Policy Committee to increase rates to offset the inflationary effect.

d) There are a number of external influences on interest rates. The ‘Funding for Lending’ scheme has succeeded in reducing mortgage rates in a way not foreseen. It has not made credit more available for SMEs because the banks still perceive risk.

There is a view that ‘Forward Guidance’ recognises that traditional monetary policy has had its day. As he prepares for a life in the House of Lords, the former Chairman of the Bank of England, Sir Mervyn King, can reflect that he failed in his last few years to meet his number one responsibility; the achieving of an inflation target of 2%.

Mr Carney is unlikely to be able to maintain his stance of ‘Forward Guidance’ because the inflationary pressures created by QE will force him to put up interest rates. Nobody will care because he was appointed by George Osborne and Chancellors are never wrong.

Please leave a comment - we all like them