SPECIAL FEATURE: Explicit guidance is just the opposite

Today’s statement from The Bank of England demonstrates very clearly its problem in providing more guidance of when the MPC will consider increasing Bank Rate without leaving the committee a hostage to fortune in the event of something completely unexpected occurring, as inevitably it will from time to time.

By saying “The committee intends at a minimum to maintain the current highly stimulative stance of monetary policy until economic slack has been substantially reduced, provided this does not entail material risks to either price stability or financial stability” the statement is obviously intended to be dovish but the initial reaction from The City, with gilt yields almost unchanged on the day, suggests it is still not convinced.

However, the indication that the timeline for not increasing Bank Rate also applies to not selling any of the existing stock of asset purchases, coupled with dangling the carrot of further Quantitative Easing, should help gilt prices in the medium term as a huge potential seller has all but ruled itself out for at least two years.

By targeting unemployment to be below 7%, as well as inflation at 2% in the medium term, we now have two specific targets for the MPC to aim at but inflation continues to be the primary target. However, to avoid being backed into a corner the MPC has wisely said that all bets are off if any of the following three ‘knockouts’ are breached:

• in the MPC’s view, it is more likely than not, that CPI inflation 18 to 24 months ahead will be 0.5% or more above the 2% target;

• medium-term inflation expectations no longer remain sufficiently well anchored;

• the Financial Policy Committee judges that the stance of monetary policy poses a significant threat to financial stability that cannot be contained by the substantial range of mitigating policy actions available to the FPC, the Financial Conduct Authority and the Prudential Regulation Authority in a way consistent with their objectives.

Mark Carney commented: “It is important to stress that forward guidance does not mean the MPC is promising to keep interest rates low for a particular period of time. The path of Bank Rate and asset purchases will, as always, depend on economic conditions.

This has some similarities in the mortgage world to Bank of Ireland offering customers a term tracker but ceasing to honour that commitment as soon as it thought it found a way of wriggling out of it!

In theory the expectation now is that Bank Rate will remain at 0.5% for at least three years as the BOE forecast is that inflation will cool gradually and reach 2% around the fourth quarter of 2015 and unemployment will stay above its 7% target until at least the third quarter of 2016, based on Bank Rate staying at 0.5% and QE remaining unchanged.

However, other forecasters may take a different view on the speed at which unemployment will fall.

“There is also the possibility that the unemployment figures may be influenced by changes in the way people are employed, which will be difficult to reflect quickly in official statistics. For example the recent controversy over zero hour contracts highlights a potential issue.

If, say, half a million of the unemployed gain employment on zero hour contracts but without actually getting the offer of much work the unemployment percentage would fall, but the economic impact would be relatively small. In these circumstances the MPC could conclude that Bank Rate should remain at 0.5% despite unemployment falling below 7%, but it would rather devalue the benefit of “explicit guidance.”

Unless the BOE pumps even more money into the system, thus increasing competition and providing scope for rate cuts, there is every reason to think that the current level of fixed rates is pretty well the floor but also there is no reason to expect rates to increase soon.

“Therefore the message for purchasers is that as fixed rates are in most cases at similar levels or cheaper than a tracker or discount, they should take a fixed rate but think about whether it should be for five or ten years, not two or five years.

A 2-year fixed rate only provides protection for a period when it is highly unlikely to be needed but actually exposes the borrower to increased interest rate risk as the early repayment charge will make it uneconomic to remortgage before the end of the fixed rate period and thus the risk is that rates will be higher if a new fixed rate is required two years later.

Some people of course will be keen to avoid being locked into ERCs for very long, which is often a deterrent from taking a 10-year fix, and in that situation a 2 or 3-year fixed rate, or a term tracker with no ERCs, is likely to be a better option.

For existing homeowners looking to remortgage there is no point in waiting in the hope of lower rates, but also no need to rush if personal circumstances dictate waiting a few months would be preferable. A couple of examples when this might be relevant are:

• Someone in an ERC period until next year.

• Someone without much equity whose LTV may soon fall below a 5% threshold, i.e. from 85% to 80%, as a result of a combination of house price increases and monthly payments on their mortgage, assuming it is a repayment mortgage, and/or making overpayments. Reducing the LTV required will often reduce the interest rate significantly, resulting in a saving well worth waiting a few months for if it means much less interest to pay over the next five or ten years. For example 5-year fixed rates up to 85% LTV start at 3.84%, whereas up to 80% LTV they start at 3.09%.