Monday, 24 August 2015

When can words do more than actions?

The Bank of England's Chairman, Mark Carney, has always tried to be open about the future plans for rises to the base rate that influences mortgage interest rates (among others) in the UK. He describes this openness as 'forward guidance', and it's designed to make sure that there aren't any surprises for banks or homeowners which could cause problems in the financial markets.

Put simply, Carney says the BoE base rate won't go up until there's less unemployment, income and spending improve and the country is meeting its output potential. The problem with this is that every time it looks like the rate might go up, as these things improve, the banks start to worry and the markets get jittery. This forces Carney and the rest of the Monetary Policy Committee to reiterate that things aren't going to change just yet.

So you see, the fear of potential change is as damaging as any actual change would be itself. This is actually quite a lot like the situation in Greece, where the uncertainty over whether or not the country would get a bailout from the European Central Bank led Mario Draghi to eventually say that the ECB would do 'whatever it takes to preserve the Euro' in 2012. This was a clear sign that he would be willing for the ECB to act as a lender of last resort to Greece and other crisis-hit countries. This was good, because it reduced fears about a Eurozone breakup and Greece's interest payments fell too. The ECB didn't actually have to step in, in the end, but convincing the markets that it would was enough.

Our consultant, Artur Oganov, contributed his views: 'If your business is having trouble, sometimes being convincing that you're going to fix stuff is as valuable as taking the steps to fix it. It can help with problems with your share price or any time people aren't confident.

'The problem with Carney was he moved the goalposts. I mean he said first "unemployment", but then added the other things. And things were meant to change after the general election, but now it seems more likely by the end of the year or early next year. This uncertainty is the big problem, but if he says "the rate will change to 1% on January 1st", then that doesn't help either because the banks price that into everything. He's in a bad spot.'

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