Mark Carney started his tenure as the governor of the Bank of England 7 weeks ago. Everyone expected, included the Canadian, that his tenure as the first non-brit heading the Bank of England was going to be filled with challenges. Mark Carney started on a strong note with an unanimous vote on his first monetary policy meeting. Aided by strong economic data there is confidence that the UK economy is on its way to sustained growth after pulling out of a recession. Carney has put a lot of faith in a signalling device called forward guidance.
Given the hermetic nature of central banks the communication between policymakers and market participants has always been filled with noise. To cut through that noise Carney used forward guidance, then at the head of the Bank of Canada, to give the market a sense of confidence that rates would remain low. The economic circumstances surrounding the Canada example are not totally comparable to the current UK situation. At that time Carney was ahead of major central banks who eventually followed in an unprecedented collective action. This time the United States Federal Reserve is gauging if the US economy is healthy enough to break the ranks of expansionary policies. This has created a different sort of turbulence that the one Carney faced at the helm of the BoC.
In early August Carney gave his first forward guidance statement. Rates in the UK would remain low and borrowing from the Fed the central bank would raise rates only after employment had improved. The chosen target was 7%. With current UK unemployment at 7.8% the Bank of England forecasted that reaching the 7% target could take up to three years.
The problem has been that the UK Economy is not complying with the plan. Report after report the data is signalling a recovery putting in question the forecasted three year timeline. This has brought criticism directed at the BoE and his governor. Forward guidance is intended to reassure the market adding a layer of transparency. The risk is exposing that the central bank might be wrong about the economy. That could be communicated as well as the data starts to diverge from the forecast.
The Fed has struggled with forward guidance in the United States. Last month Fed members stated that the market did not understand or overreacted to the tapering comments from the central bank. Bernanke has resorted to using more obtuse language to reduce expectations. This approach has gone against the original principe of forward guidance which relies on transparency and accuracy to deliver the strongest message. The US has the added complication in the fact that Ben Bernanke will not be the head of the Fed next year. The probability that the exiting Fed chief will start a massive tapering program before heading out the door has also added to the speculation on the end of QE timeline.
The pound has enjoyed a steady climb since July 9. Even the currency did not comply with the Carney initiative and was unmoved by the lower rate environment statement. The GBP has been a better gage of the economic recovery that the estimates from the central bank. The currency could drop, but it seems that the Fed’s tapering comments are driving more of the market behaviour than the Bank of England. A clear timeline on tapering form the Fed could dispel all the uncertainty. A start of tapering in the fall or even this year looks likely with every positive US economic indicator. At the same time every missed forecast has casted doubts that have turned this summer into one of the most volatile on record.
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