Not since the early 1990s, when the Bank of England was trying to peg the pound to the deutschmark in an effort to keep Britain within the exchange rate mechanism, has a policy had quite such a rough time in the markets as forward guidance'. On taking over from Sir Mervyn King, Mark Carney imported it from Canada. He promised to keep interest rates at their current 300-year lows for a prolonged period. And how did the City respond? It promptly sent rates sharply upwards. If it had chosen just to blow raspberries at the new governor, it could not have made its feelings much more clear.
Yet it would be wrong to conclude as much of the City seems to have that forward guidance' is now completely irrelevant. Carney is being listened to by the wrong people. Professional investors are not paying him any attention, but ordinary people are, and they are starting to ramp up their borrowing as a result. The trouble is, that is precisely the reverse of what should be happening.
Forward guidance worked for Carney in Canada. After the crash of 2008, he promised to keep interest rates low for a sustained period of time. The theory was that companies and consumers would then have the confidence to go out and borrow to invest, safe in the knowledge that rates would not rise. It made some sense and seemed to work. Canada kept on growing while the rest of the world was stuck in a slump.
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But Canada has a small, passive financial market whereas London has a big, bolshie one. The Canadian markets kept rates low, just as they were expected to. The London markets immediately started pushing rates up. In May, as Carney was preparing for his new job, the cost to the government to borrow money over ten years was just 1.6%. By the middle of August, the ten-year gilt yield had hit 2.7%, almost double the low of September 2012. Forward guidance was meant to persuade the City to keep rates low, and get companies investing again. But they have chosen to ignore it.
Professional investors are well aware that what happens over two or three years is largely outside the governor's control. If inflation rises rapidly, rates will go up. If the economy recovers faster than anyone expected, and unemployment drops rapidly, they will go up. If sterling goes into free fall, rates will go up. If there is a war in the Middle East, or a major crash in China, rates will go down. There are so many things that might happen over that time frame that it is hardly worth listening to what the governor has to say. Judged by the impact on the markets the audience it was designed for forward guidance has been a failure.
But another audience is paying rapt attention ordinary borrowers and savers. They have taken Carney on his word, and are taking up every loan the finance industry throws at them. In July, mortgage lending hit its highest level since October 2008. A total of £16bn was lent out to finance property purchases. The same is true of personal debt. According to the Bank of England, consumer credit is now rising at its fastest pace since December 2008. Total consumer credit rose by £600m in July, up from £400m in June.
The bulk of that rise was in other loans and advances', which mainly includes overdrafts and personal loans. These were up by £500m, compared with an average monthly increase over the previous six months of £200m. In short, people are maxing out their credit cards once again and no doubt loading up on loans from Wonga too. Yet real (after-inflation) incomes are significantly lower than they were five years ago and unemployment is higher as well. So people are borrowing more with less income and less certain income at that.
Still, why not? After all, no less a person than the governor of the Bank of England has told them he plans to keep interest rates very, very low for a long time. The risk of borrowing money that rates may rise sharply and leave you struggling to keep up the payments has been taken off the table. You'd be crazy not to borrow, certainly to buy a house. And you may as well take out a loan for a new TV too.
The professionals know that Carney can no more promise to keep rates low than he can promise a white Christmas. What happens to the cost of money depends on factors outside his control. What he is trying to do is create an illusion of confidence, to get borrowing growing again, stimulate investment, and get sales up on the high street. It is a kind of conjuring trick: move your hands fast enough, keep the audience distracted, and it looks like magic. If they see through the trick, however, it stops working.
The City has seen through forward guidance. But increasingly, it looks like a way of duping the financially unsophisticated and persuading them to borrow more than they can really afford. That is hardly a worthy objective for the Bank of England and if we end up with another debt crisis, Carney will deserve much of the blame.
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