(MENAFN- Khaleej Times) The worry about the Bank of England's (BoE) 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 per cent as long as unemployment, now 7.8 per cent, is higher than seven per cent.
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 per cent 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 US 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.
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 ($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 per cent 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 US 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.
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