At the beginning of May the UK government could borrow for 10 years at just over 1.6% per annum. Yesterday that rate rose to just over 2.6%, a full 1% or 100 basis points increase. This has happened despite Mr Carney’s very clear indications that he intends to keep short term interest rates low for the forseeable future, short of a major upset on inflation.
So why have the markets responded like that to his Forward Guidance? After all that was designed to keep interest rates and interest rate expectations low. There are two main reasons. The first is the strong impact US rates have on us. US rates have risen even further than in the UK in recent weeks. Secondly, the UK economic figures have come out much better than expected, bringing forward investors’ ideas of when rates might or should rise, despite the Guidance on official short rates.
US rates have risen on expectations that the Fed will soon end its large Quantitative Easing programme. They have risen despite various attempts to reassure people that the stimulus will not be withdrawn prematurely, to damage recovery. When the UK withdrew or temporarily suspended its QE programme there was no such impact.
Central bankers have to try to guide market expectations in the way they wish, to keep enough confidence in an economy without letting inflation race away. So far in his short time as Governor Mr Carney has been lucky, that he arrived just as the UK economy was showing good signs of revival. He was less lucky with the background for launching forward guidance. The US pushing rates up has had more impact on the UK bond markets than the Bank’s statements. It has produced the irony that the Governor’s policy was designed to keep rates down, yet the markets have pushed borrowing rates up rapidly for the government.