A little time has passed since Bank of England Governor Mark Carney announced the new policy of forward guidance for the Bank’s interest rate setting committee, the MPC. So how have the markets reacted in the early days?
Here’s a quick recap of the new stance.
The MPC will not even think about raising interest rates (or indeed selling any of its purchased assets, what you might call Quantitative Difficulting!) until the unemployment rate drops below 7% unless:
a) Inflation looks like being way off track - more than 0.5% above the target over their 2-year forecasting model
b) Expectations of inflation go off track – in other words, people think it’s going to be way higher than the Bank does
c) The Bank’s Financial Policy Committee thinks it’s putting economic stability at risk
The Bank’s latest forecast says will probably take about 3 years for unemployment to get down to 7%.
Given such a radical shift and clear timeframe you might expect some dramatic reaction in the markets. Initially there wasn’t, which seemed a bit odd, although some element of forward guidance had been expected for months so perhaps it had already been priced in.
Indeed swap rates (basically, the wholesale cost of a fixed mortgage) were already drifting upwards before Governor Carney’s announcement. However once we got past the weekend, the market rates jumped in a big way. Here’s the change since the start of August:
So the pattern is pretty much what you’d expect given a “no change for about 3 years” outlook with rather greater increases on the longer rates.
But the fact that 2-year rates have already gone up 0.15% suggests a degree of scepticism (or perhaps optimism) about that 3-year timescale.
To put that in context, here’s the swap rates over the course of the year:
That jump at the end starts on 1st August and just keeps going up, and the gap between shorter and longer term rates is now appreciably wider than it’s been all year.
Against that background, the current crop of 5-year fixed rate mortgages look particularly good, and if this pattern is maintained (never mind extended) they’re likely to come under some pressure before too much longer.
At the same time shorter rates – though cheaper – now have a greater air of gamble about them. Of course nothing has really changed about that: there’s no guarantee that rates will be higher in 3 years time, and a couple of years ago you couldn’t have known for certain that rates would be this low now.
But the Bank of England’s forward guidance now puts that question of risk into sharper relief and – potentially – may increase the price of protecting against it.