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SPECIAL FEATURE: The Pied Piper of Threadneedle

Robyn Hall

August 13, 2013

Seldom can the appointment of a new governor of the Bank of England have resulted in quite so much media spin and City optimism as Mark Carney’s. In the first week after his arrival at Threadneedle Street, the FTSE 100 rose 6%, supposedly on the strength of a modest upturn in the UK’s services sector output levels and reported GDP growth of 0.3%.

However as underwhelmed as City analysts might normally have been by those numbers back then their collective optimism was being buoyed by Mr Carney’s track record on monetary stimulus and explicit “forward guidance” on future interest rates. That optimism was enough to send shares soaring on the slightest good news.

The piper’s favourite tune

As the Financial Times reported of Mr Carney at the time of his appointment, “forward guidance” is a policy that is “close to his heart”. His use of the technique at the Bank of Canada in 2009 is credited with helping to stabilise the Canadian economy – or it is by his supporters at least. His critics blame it for fuelling a property bubble. They consider that he kept monetary policy too loose for too long and acted for ostensibly political rather than economic reasons.

Same song – new audience

Fast forward to last week’s press conference on the Bank’s monthly inflation report when we finally got to see what form “forward guidance” would take – now transplanted to the UK of 2013.

There were a number of forms that forward guidance for the UK could have taken but it can hardly be much of a surprise that in setting the conditions for rates to remain static, the key indicator he has chosen to target is the unemployment rate – following the Fed in the US – nor that the timescale indicated by the chosen target of a 7% unemployment rate will maintain interest rates at their current historical lows until after the next general election.

To be fair, the minutes from July’s Monetary Policy Committee meeting had already set the scene.

The minutes of that meeting – Carney’s first –showed that members were unanimous in their decision to hold the bank rate 0.5% and QE at £375bn. Those minutes also recorded that the Committee was “concerned” (for which I read “scared witless”) by the recent volatility in markets both sides of the Atlantic after the US Federal Reserve made just the slightest mention of the possibility of “tapering” or reducing their QE levels from $85billion per month, sometime in the future.

The Monetary Policy Committee recognised that even the slightest suggestion that cheap money will not be maintained (effectively) indefinitely or that QE will start to be reversed, is not a risk that Carney or his political masters can consider. Well not unless they are prepared to preside over a very inconvenient fall in the FTSE and rise in market interest rates. Hence the no surprises announcement.

Are people really going to follow the Piper down this path?

You would think that the lessons of under-pricing debt would have been learned by now but Mr Carney doesn’t really have any other tricks up his sleeve that can better deliver the short term results that the Government wants: An increase in consumer spending fuelled by increased debt levels; a buoyant housing market, positive headlines from the stock market indices, and low rates payable on its own public sector borrowings. Hence George Osborne’s call in the last Budget for the Bank of England to employ “unconventional” policy measures, and trumpeting that Mr Carney was the man for the job.

The Government is depending on there being no bad news from the housing or stock markets before the next General Election.

The maintenance of negative real interest rates should be viewed in the context of Mr Osborne’s hopes to attain growth through increased housing construction and to win votes by getting more consumers onto the housing ladder – a well-thumbed page of the Conservative party playbook.

Hence, we now have the Funding for Lending scheme; £12 billion to guarantee up to £130 billion of mortgages; and the Help to Buy scheme which could benefit up to 570,000 borrowers over the next three years.

All of these schemes should encourage lenders to offer lower rates for borrowers with small deposits.

Mr Osborne’s policies, with Mr Carney’s soothing soundtrack piped consistently in the background will create incredibly (unrealistically) favourable conditions for the mortgage and housing markets in the run up to 2015/6.

Such a pretty tune…

Low stable interest rates, plenty of funding, a guarantee to protect lenders and a steady supply of optimistic rhetoric in the news to encourage already over-extended borrowers to extend themselves even further.

Just look at the gushing media response last week hailing the slight uptick in June manufacturing and service output figures as a recovery.

“Just wow!” was the widely reported comment of one giddy, prominent analyst. No mention of just how miniscule those increases actually are in relation to the fall in the same metrics over the past five years – and no mention of the statistical anomalies at play when comparing June 2013 to the shortened working month of June 2012. (Diamond Jubilee weekend ring any bells?)

Whether Carney’s forward guidance turns out to be prudent economic management or political expediency – the probability is that it will result in the next few years being a great time to be a mortgage broker.

So polish up your dancing shoes and get ready for the party. Just try to remember that there will be a morning after and the hangover will eventually hit.

What happens when the music stops?

Well, by then, seven years of base rates being held at their lowest level in the Bank’s 300 year history will have passed, encouraging already highly indebted businesses and individuals to take on more debt. Meanwhile the UK’s savers and solvent businesses, will continue to suffer negative real returns and see their real wealth eroded, suppressing the prudent spending and investments they might otherwise have undertaken with money they actually have.

Large insolvent zombie businesses clinging onto dominant market shares only by virtue of the low interest rates will continue to slow the progress of more efficient newcomers. “Creative destruction” – the real engine of free market capitalism – will have taken a nice long nap.

Market interest rates will have been low enough for long enough that a huge number people and businesses will have adapted to this as the new ‘norm’ and will be even less prepared for any increase in rates than they are now. But increase they will, in the end.

So while we in the mortgage-related industries enjoy the bonanza to come in the next few years, let’s also try to educate our clients, and encourage them not to lose sight of the fact that one day the piper will have to be paid.


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