Opinion

James Saft

Chief virtue of new BOE plan is it won’t work: James Saft

August 8, 2013

Aug 8 (Reuters) – The worry about the Bank of England’s new
policy of forward guidance is not so much that the market
doesn’t appear to believe it, though that can’t help, as the
extent to which the whole plan depends on house price gains.

The BOE this week enunciated a new policy of providing the
market with forward guidance, saying it was unlikely to raise
interest rates above their current all-time low of 0.5 percent
as long as unemployment, now 7.8 percent, is higher than 7
percent.

Forward guidance, introduced by star new BOE chief Mark
Carney, is intended to drive down longer-term rates and thus
goose asset prices. It also includes a few get-out clauses which
would allow for a hike. Carney said the bank might raise rates
even if unemployment remains high: if medium-term inflation
expectations rose too much; if its own, notoriously poor,
forecasts showed inflation in 18 to 24 months will be 2.5
percent or higher; or if low rates pose a threat to financial
stability.

The BOE, again citing its own highly fallible forecasts,
said it didn’t see rates rising before late 2016.

There are two big problems with this strategy: it probably
won’t work and, if we really think about it, we probably don’t
want it to.

“The Monetary Policy Committee seems to be attaching a lot
of importance to further recovery in the UK housing market. In
an attempt to emulate the Fed’s apparent success in boosting the
U.S. recovery, the BoE is trying to create conditions that will
support demand for properties and equities,” Valentin Marinov,
foreign exchange strategist at Citigroup, wrote in a note to
clients.

This is a page straight out of the Federal Reserve’s
play-book, though done less forcefully. Low longer-term rates
should drive up stock prices and stoke Britain’s already bubbly
housing market. That, in turn, will not only drive consumption,
but, as paper gains in houses and stocks are turned into
holidays and marble countertops, it will also create jobs.
Finally low long-term rates will help encourage businesses to
invest and allow banks to make easy profits, thus repairing
their very threadbare balance sheets.

One big problem with all of this is not so much whether we
believe the BOE, but what exactly it is they are pledging to do.
In sum, not much. The unemployment level is a threshold for
discussion rather than a red button to launch rate rises. As
well, the BOE has given itself so many outs as to make the whole
exercise a pledge to “do the right thing,” whatever that might
be.

Rates actually rose briefly after the announcement and the
pound went up in value, both the opposite of what Carney
presumably hoped.

SHOUTING ‘FIRE!’ IN AN UNBALANCED ECONOMY

The bigger problem is the extent to which the BOE is tying
its, and Britain’s, fortunes to its notoriously frothy housing
market. In some ways it is easy to have sympathy for Carney and
his BOE colleagues; they have precious few potential sources of
growth. Trying to get an export-driven revival hasn’t worked and
won’t work because Europe, Britain’s most important trade
partner, continues to wallow in something doing a passable
impression of a depression.

This is not a new problem for Britain, and Carney’s is not a
new solution. Over the 15 years or so before the crisis began in
2007, Britain enjoyed very good and stable growth, but did it by
encouraging the over-development of its ‘FIRE’ sectors -
Finance, Insurance and Real Estate. That is how Britain found
itself with huge private debts and banks and house prices which
were grossly out of proportion with its ability to support them.

Turning back to this sector as the engine of growth is
risky, and wrong-headed. House prices in Britain are already on
the rise, and may rise more rapidly next year when the “Help to
Buy” government program kicks into high gear next year. Under
Help to Buy, Britain will guarantee mortgages on homes bought
for as much as 600,000 pounds ($920,000). Ratings agency Fitch
warned that the plan may push up house prices and increase
taxpayer liabilities without doing anything to ease Britain’s
housing shortage. House prices have risen 4.6 percent in the
past three months alone.

Why the BOE and government would work to build another
housing bubble is unclear. Britain’s ratio of private debt to
GDP has gone down a bit but is still much higher than in either
the U.S. or the euro area.

Britain has a tough road ahead; it needs to further
diversify its economy and slowly shrink its debt, all while
allowing finance and its handmaidens to gently decline.

Forward guidance is, at best, a hesitant attempt at a
strategy we already know ends badly.
The worry about the Bank of England’s new policy of forward
guidance is not so much that the market doesn’t appear to
believe it, though that can’t help, as the extent to which the
whole plan depends on house price gains.

The BOE this week enunciated a new policy of providing the
market with forward guidance, saying it was unlikely to raise
interest rates above their current all-time low of 0.5 percent
as long as unemployment, now 7.8 percent, is higher than 7
percent.

Forward guidance, introduced by star new BOE chief Mark
Carney, is intended to drive down longer-term rates and thus
goose asset prices. It also includes a few get-out clauses which
would allow for a hike. Carney said the bank might raise rates
even if unemployment remains high: if medium-term inflation
expectations rose too much; if its own, notoriously poor,
forecasts showed inflation in 18 to 24 months will be 2.5
percent or higher; or if low rates pose a threat to financial
stability.

The BOE, again citing its own highly fallible forecasts,
said it didn’t see rates rising before late 2016.

There are two big problems with this strategy: it probably
won’t work and, if we really think about it, we probably don’t
want it to.

“The Monetary Policy Committee seems to be attaching a lot
of importance to further recovery in the UK housing market. In
an attempt to emulate the Fed’s apparent success in boosting the
U.S. recovery, the BoE is trying to create conditions that will
support demand for properties and equities,” Valentin Marinov,
foreign exchange strategist at Citigroup, wrote in a note to
clients.

This is a page straight out of the Federal Reserve’s
play-book, though done less forcefully. Low longer-term rates
should drive up stock prices and stoke Britain’s already bubbly
housing market. That, in turn, will not only drive consumption,
but, as paper gains in houses and stocks are turned into
holidays and marble countertops, it will also create jobs.
Finally low long-term rates will help encourage businesses to
invest and allow banks to make easy profits, thus repairing
their very threadbare balance sheets.

One big problem with all of this is not so much whether we
believe the BOE, but what exactly it is they are pledging to do.
In sum, not much. The unemployment level is a threshold for
discussion rather than a red button to launch rate rises. As
well, the BOE has given itself so many outs as to make the whole
exercise a pledge to “do the right thing,” whatever that might
be.

Rates actually rose briefly after the announcement and the
pound went up in value, both the opposite of what Carney
presumably hoped.

SHOUTING ‘FIRE!’ IN AN UNBALANCED ECONOMY

The bigger problem is the extent to which the BOE is tying
its, and Britain’s, fortunes to its notoriously frothy housing
market. In some ways it is easy to have sympathy for Carney and
his BOE colleagues; they have precious few potential sources of
growth. Trying to get an export-driven revival hasn’t worked and
won’t work because Europe, Britain’s most important trade
partner, continues to wallow in something doing a passable
impression of a depression.

This is not a new problem for Britain, and Carney’s is not a
new solution. Over the 15 years or so before the crisis began in
2007, Britain enjoyed very good and stable growth, but did it by
encouraging the over-development of its ‘FIRE’ sectors -
Finance, Insurance and Real Estate. That is how Britain found
itself with huge private debts and banks and house prices which
were grossly out of proportion with its ability to support them.

Turning back to this sector as the engine of growth is
risky, and wrong-headed. House prices in Britain are already on
the rise, and may rise more rapidly next year when the “Help to
Buy” government program kicks into high gear next year. Under
Help to Buy, Britain will guarantee mortgages on homes bought
for as much as 600,000 pounds ($920,000). Ratings agency Fitch
warned that the plan may push up house prices and increase
taxpayer liabilities without doing anything to ease Britain’s
housing shortage. House prices have risen 4.6 percent in the
past three months alone.

Why the BOE and government would work to build another
housing bubble is unclear. Britain’s ratio of private debt to
GDP has gone down a bit but is still much higher than in either
the U.S. or the euro area.

Britain has a tough road ahead; it needs to further
diversify its economy and slowly shrink its debt, all while
allowing finance and its handmaidens to gently decline.

Forward guidance is, at best, a hesitant attempt at a
strategy we already know ends badly.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Editing by James Dalgleish)

Comments
One comment so far | RSS Comments RSS

In spite of the fact that years ago I earned a BS in Economics and should “know better”, I’ve always considered a home an asset. I’ve never considered it an investment. I’ve never borrowed against it. I never really cared about it’s increase or decrease in value for one simple reason. If and when I sell it, we’ll need another place to live. If prices go up, in the aggregate, we’ll get more for our current home and pay more for our future one. Same holds true, on average, if prices decline.

Twenty years ago when we bought our home we had a neighborhood full of young families. There are some new young families here but there are many more “kids” in their 20′s still living at home with their parents. These are college educated generally intelligent people who don’t have the earning power to get out there on their own. It’s sad, we’re losing a generation.

Posted by Missinginaction | Report as abusive
 

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