The phrase ‘forward guidance’, introduced into the financial dictionary earlier this week by Mark Carney, the new Bank of England Governor, sounds innocuous enough. But for better or worse, it will soon affect each and every one of us over the next few years.
First things first, what does ‘forward guidance’ mean?
Put simply, the Bank of England’s Monetary Policy Committee (MPC) is tasked with keeping inflation at 2%; not higher, not lower, but at 2%. The main lever it has to affect inflation is of course interest rates and as a result bank base rate has been stuck at 0.5% for over four years. Yesterday however, Mr Carney announced a change in policy; he now intends to keep base rate at 0.5% until unemployment drops to 7%. He believes a further 750,000 jobs will need to be created to meet this threshold which will take around three years.
Mr Carney did give himself some wriggle room, or ‘knockouts’ as he calls them, which could see rates start to rise sooner, if inflation threatens to move significantly above target, or there are other threats to the nation’s finances, such as another housing bubble.
Both the Prime Minister and the Chancellor welcomed the news, pointing out that having some interest rates aren’t about to leap up will benefit both business and personal borrowers and consequently the wider economy.
But is it really such good news? How will it affect people without borrowings? We thought we’d take a look at who the winners and losers of ‘forward guidance’ are.
New mortgage borrowers
Anyone buying a new home within the next three years can now reasonably expect interest rates to stay at the current lows. The Funding for Lending scheme is here to stay for at least a couple of years and it’s now clear bank base rate won’t rise in the short term, unless something unexpected happens.
We’ll also probably see more borrowers opting for shorter, two and three year variable rate deals rather than fixed rates now there is more certainty rates are unlikely to rise sharply.
Borrowers with a tracker mortgage
Tracker mortgages are generally linked to Bank of England base rate. Anyone with such a deal will be delighted by Mark Carney’s announcement, which gives them reasonable certainty for the next few years and with the unemployment figure easily available, any possible rise in interest rates will be easy to spot.
Most homeowners like to see the value of their property rise and ‘forward guidance’ will certainly help boost prices, as continued low interest rates will boost the mortgage and housing markets, already reinvigorated by the Help to Buy and Funding for Lending schemes.
Most business loans, unless arranged on a fixed rate, are linked to the base rate. The news therefore will give business borrowers certainty rates are not about to jump up, which will help with their cash flow planning.
That is of course providing banks simply don’t increase their margins to take advantage of the low base rate. Of course, they wouldn’t be so cynical, would they?
Savers will probably lose out the most from ‘forward guidance’, however investors should gain.
The higher degree of certainty around interest rates should be positive news for equity markets, which will translate into positive investment returns for those people using their ISAs and Pensions to invest in the stock market.
The biggest group to lose out will be those people who have done the right thing and put money aside for their future. With the interest rates being held steady until unemployment falls to 7%, savers can expect the double whammy of low interest rates and seemingly unchecked inflation. This will result in a guaranteed real terms loss for most savers.
It is now impossible for taxpayers to find a savings account which beats inflation and it seems that holding money in Cash simply guarantees it will be worth far less, in real terms, when rates do eventually start to rise.
Rightly or wrongly most retirees use an Annuity to turn their pension pot into an income.
Annuity rates are linked to two main factors, gilt yields and long term interest rates. This week’s announcement, that interest rates will stay low for at least three more years, will put downward pressure on Annuity rates, perhaps snuffing out any hope that the recent rate rises will continue.
First time buyers
Whilst low interest rates should in theory help all mortgage borrowers, unless of course you are on a fixed rate, rising house prices will do nothing to aid the plight of first time buyers.
Survey after survey shows the main barrier to first time buyers getting onto the housing ladder is the time it takes to save a deposit, especially whilst rents are rising too. A surge in house prices, on the back of continued low interest rates, will do nothing to help first time buyers.
What action should you take now?
Whether you are a winner or loser, this week’s announcement from Mark Carney should be the signal to review your personal finances.
Look out for the articles we’ll be publishing over the next week or so, giving practical hints and tips for all those people affected by the announcement.