What price forward guidance when markets move faster than the Bank?

Unlike the Fed, Threadneedle Street is sending mixed messages, with no policy action and a fudged inflation target

Central bankers have feet of clay. That was the clear message from the surprise decision by the Federal Reserve to shelve plans to start withdrawing its colossal monthly stimulus to the US economy. Ben Bernanke, the Fed's chairman, may have thought that he had communicated his thinking clearly to the markets, but the announcement came as a bombshell to an unsuspecting Wall Street.

So, if there is a lesson to be learned from last week's shenanigans, it is that providing "forward guidance" to the public is a lot more difficult than it looks. That applies to the Fed, and it applies to the Bank of England, because the conduct of monetary policy in the UK is looking even more confused than it does in the United States.

Mark Carney announced his arrival at Threadneedle Street this summer with a bang. A statement was issued after his first meeting as chairman of the Bank's monetary policy committee stating bluntly that the increase in long-term interest rates, in large part due to the Fed whipping up speculation about tapering its stimulus, was "unwarranted".

Carney followed this with his forward guidance statement to the markets in August, in which he pledged that the Bank would keep official interest rates on hold at least until unemployment fell to 7%.

According to the Bank's forecasts, that would take until 2016, although Carney announced three "knockouts" that could bring forward the date of increasing the cost of borrowing. One of these was that the Bank would consider raising interest rates if inflation threatened to be above 2.5% in 18 to 24 months' time.

Now compare and contrast the respective response of the Fed and the Bank of England to movements in market interest rates in recent months.

Both institutions are concerned that the tightening of monetary conditions that has resulted from higher bond yields could slow down economic recovery. Both would prefer to see long-term interest rates slipping back towards the levels they were at in May, before the Fed announced its intention to taper.

The Fed has now made its policy stance abundantly clear. It is prepared to tolerate slightly higher inflation in the short term in order to avoid the risk of the inflation undershoot that would result from killing off the recovery. It has backed up forward guidance with action. Bernanke has sent out a warning to financial markets: don't mess with the Fed.

If only the position in the UK were so clear-cut. The Bank of England has moved from a 2% inflation target to a 2.5% inflation target, but is insisting that it hasn't.

Having asserted that the rise in bond yields between May and July was unwarranted, it has said nothing about the further increase in long-term rates that followed the City's lukewarm response to forward guidance. And nowhere in the minutes of September's rate-setting meeting is there any suggestion that a 10-year bond yield of 3% is unjustified – so the assumption has to be that the Bank believes it is justified.

As for policy action that would back forward guidance, that is growing more unlikely by the month. Growth in both the third and fourth quarters of 2013 will be higher than the Bank envisaged in the August inflation report, and it would take only a modest revision to output forecasts – of around 0.25% a year – to bring back to 2015 the date by which unemployment hits 7%.

Businesses and individuals have been more willing than the City to take Carney at his word – taking out loans in anticipation that rates will stay on hold until 2016. Yet without policy action, or at the very least an admission that the inflation target has been watered down, the Bank's commitment to low borrowing costs looks less than rock-solid. Borrowers beware.

David Simonds Co-op 22.09.13
Cartoon by David Simonds Photograph: Observer

Funds hope for richer pickings than Co-op will offer them

The vultures have started to swoop on the Co-operative Bank. Two US hedge funds – Aurelius and Silver Point Capital – along with a motley assortment of investors, own more than 40% of the Co-op's debt.

Their appearance should not be surprising: when companies run into trouble, investors such as these often see the opportunity for rich pickings. That is not so say that the Co-op is a carcass, but it is a business that needs reviving: it has to find the £1.5bn the Bank of England has deemed necessary to plug a capital shortfall.

Even so, the presence of the hedge funds, which term themselves the "LT2 Group" after the lower, tier-two class of debt they own, is an embarrassment for the Co-op, which only last month was insisting the only alternative to its complex recapitalisation plan was nationalisation. The LT2s have a simple scheme: they want a pretty straightforward debt for equity swap, turning their £1.3bn of debt into shares. The hedge funds would then have substantial control at the bank.

The Co-op's plan is anything but straightforward – although, crucially, it would allow the grocer-cum-pharmacy-cum-funeral homes group to remain the key shareholder in a floated bank. But now, with the bank agreeing to consider the LT2s' proposal and set up an independent committee for that purpose, the end of December deadline set by the regulators to find most of the capital seems uncomfortably close.

That is a worry. Not for the bank's customers, whose cash is guaranteed (up to £85,000) by the government, but for the regulators. The process the Co-op bank is going through is known as bail-in; it is the new regulatory alternative to a taxpayer bailout, with the bondholders stepping in to fill in the shortfall that government might otherwise have to fill. But, as this episode shows, bondholders are unlikely to sit back and take losses without a fight.

East Coast is a state railway success. Let's have more

With Iain Duncan Smith and George Osborne's reforms providing so many fish to shoot in a barrel, Labour doesn't want to train its sights on a trickier target. So instead of calling for full-scale rail renationalisation at conference this week, it will keep pushing the case to keep East Coast public. Where private operators have sucked money from the system, state-backed Directly Operated Railways has been returning money to the Treasury – and has run an efficient, popular service.

Absurdly, it is barred from bidding for franchises, while firms owned by the French, German and Dutch states are free to do so. Renationalisation sounds like the kind of ideological position New Labour feared taking. But millions fed up with high fares share the opinion of one M Thatcher: that rail was a privatisation too far. Labour can afford to be bolder.

The GuardianTramp

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