Those of you with their fingers on the pulse of the UK economy, will be well aware of the recent “big introduction” from Mark Carney – new Governor of the Bank of England. I refer, of course, to his ‘Forward Guidance‘ on interest rates, which – as we mentioned in our last post – is essentially a strategy that aims to provide as much information as possible on when interest rates are likely to increase [from their record low rate of 0.5% – plus £375bn of Quantitative Easing (QE), which effectively means they are zero].
Why is forward guidance important?
From a market perspective, they always say “we don’t like surprises”; what they actually mean is we don’t like major changes in the dynamics of the market that they haven’t foreseen, and consequently hedged against!
From a business perspective, all large corporates and a lot of the mid-market will have teams of people forecasting how and when changes are likely to come, and how they can start to manoeuvre their business for it, to be fully prepared. Scenario planning will play a major part in this.
For the SME, who hasn’t had the luxury of the bond markets and lots of ‘fat’ that can be trimmed, the last five years have been very difficult. Cash flow has been king, in a market with very few business finance solutions available for the smaller business. Those businesses that have continued to work through the period with the burden of debt taken on pre-2008, have survived largely through low interest rates. Those that have not been able to restructure this debt have increasing bank rate or LIBOR hanging over them like the proverbial sword of Damocles.
For the consumer, particularly those with big mortgages (who are also often the drivers of the businesses referred to above), who haven’t been able to pay down their debt in the last 5 years, this Forward Guidance gives them the opportunity to do something before rates creep to the norm of 4.5% to 5.00%.
We are hearing every day – as if we needed reminding – that, despite the fact it seems we are coming through the other side of the current financial crisis, living standards (i.e. low wages plus high inflation) have not kept pace with inflation over this past 5 years. Consequently, for folk already at their limits any increase in interest rates will be a problem.
What are the implications going “forward”?
Forward Guidance, it would seem, is a benefit to all of the situations listed above, as it gives businesses and individuals alike, the opportunity to plan. However, as I see it there are two potential problems ahead:
1. Potential asset bubbles – house prices
Those with the ability to borrow might just be tempted to dive into the property market, with house prices still depressed in many areas. This is particularly the case with the “Help to Buy” scheme predicted to create an increase in prices over the next few years. This would be good in the short term for government coffers, with all the attendant benefits, such as stamp duty increases and corporation tax receipts from all the homeware companies, but also has the potential to cause mayhem in the medium term given the still fragile state of the global economy.
2. Rate of increase?
Forward Guidance for market makers and corporates is great in the short term as it is giving these organisations (that are often as manoeuvrable as an ocean liner) the time to do something now. The missing bit of the story is what will be the pace then of any increase in rates come late 2015 or early 2016?
This lack of guidance could cause additional problems, according to Richard Barwell, senior European economist at Royal Bank of Scotland, and Jagjit Chadha, a professor of economics at the University of Kent. They argue in their recent article ‘Turning forward guidance into 20:20 vision’, that the current level of Forward Guidance “serves to reduce uncertainty in one dimension but increase it another”.
Only time will tell if the Forward Guidance strategy makes Mark Carney the new King (pun intended albeit not very funny!).
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Image by: Dr Ewan