The first sniff of change at the Bank may mean more of the same

There are costs to the present ultra-loose policy that are already showing through

A new Governor, a new policy – or at least a new rationale for the existing policy. We have now had the first sniff of a change of direction, in that the Bank of England will now take the level of unemployment explicitly into account before deciding to hike interest rates.

It may indeed turn out that the first increase in rates – and the start of selling back to the public the pile of national debt held by the Bank – will take place a bit later than previously expected. But before you buy the “new man at Bank gives boost to economy” story consider three things.

First, monetary policy is already extraordinarily loose, with official interest rates at 0.5 per cent, and the Bank having bought more than one-third of the national debt. Policy will have to tighten and the only issue is when.

Second, the economy now seems to be growing at an annual rate of more than 2 per cent, close to its long-term trend. Given the strength on the labour market it is plausible (though the Bank does not expect this) that unemployment could fall below 7 per cent next year. So the market expectation, ahead of today’s meeting, of a rise in rates next year may still turn out to be correct.

And third, there are costs to the present ultra-loose policy that are already showing through and will become more evident the longer it lasts.

We should not be too purist about all this. Having an unemployment target as well as an inflation one is a recent innovation, first mooted by Ben Bernanke, head of the US Federal Reserve, at the end of last year. But the idea that a central bank has a responsibility for overall financial stability as well as being a custodian for the value of the currency goes back to the development of central banking in the 19th century.

Actually, inflation targets themselves are a recent innovation in that they date back only to the 1990s. That led to what we can now see as a mistake in policy here and elsewhere from the late 1990s onward. Inflation was temporally depressed by the advance of Chinese manufacturing and by focusing on current inflation (which seemed fine), central banks permitted excessive borrowing and a surge in asset inflation – the bubble that burst in 2008.

So you could say that by bringing unemployment into the Bank of England’s thinking, all that Mark Carney is making explicit is the general responsibility of any central bank that monetary policy should be consistent with stable economic growth.

Too loose a policy leads to asset price bubbles and subsequent banking crashes; too tight a policy unnecessarily inhibits growth. The common sense interpretation of the Carney guidance therefore runs something like this: “We will have to tighten monetary policy at some stage, but do not expect us to do so until unemployment has dropped significantly – and fall to 7 per cent would be significant – and remember that we must retain our concern about inflation, so that will affect policy too.”

So will there really be no change in interest rates for three years, the period implicit in the guidance? I personally think that is most unlikely, partly because I expect unemployment to come down faster than the Bank forecasts but more because the global interest-rate cycle is turning up, led by the US.

You can see this already at longer maturities. A year ago 10-year gilts carried an interest rate of 1.6 per cent; today it was 2.5 per cent. The reason is largely that savers saw that ultra-low rates were unsustainable and invested in other things. Central banks can control very short-term rates, but not longer-term ones.

A final thought. Unemployment matters terribly. Indeed, it remains a scourge on Western societies and anything that can be done to reduce it deserves support.

But for the long-term health of society, savers – battered by four years of dreadful returns – matter too.