Carney’s break from the past

The Bank of England’s new governor, Canadian Mark Carney, has taken some bold steps with his monetary policy that could shape markets for years to come.

In contrast to his more pragmatic predecessor, Mervyn King, Carney has set out a long-term goal which is set to see interest rates sit at their current historic low of 0.5% for years to come.

Following the first Monetary Policy Committee meeting with Carney at the helm, the new governor released a statement saying that interest rates will not rise until UK unemployment falls to 7%, which is not expected until 2016, stating he did not want to hamper economic growth for the sake of controlling inflation.

Ever since the Bank of England was given freedom to set its own interest rate by former chancellor and prime minister Gordon Brown back in 1997, the central bank has primarily focused on keeping inflation at its 2% target rate. The introduction of a second measure, which is likely to see inflation above target for many years to come, is highly unorthodox and was inevitably felt on London’s markets.

To start with the good news, the FTSE 100 jumped dramatically shortly after Carney’s statement. The main London benchmark jumped 191.8 points, or 3%, to register its biggest single-day rise since September 2011.

Clearly corporates continue to struggle with financing and depressed demand and any respite for the economy is certainly good news for British businesses. His lack of commitment to further quantitative easing (though he certainly hasn’t ruled it out) could also contribute to greater equity market activity, which has been depressed in recent years.

However, the news that interest rates will be effectively negative when factoring in inflation for the next few years hit sterling hard and the currency saw a sharp drop against the dollar in the aftermath. It also dropped relative to the euro, which is expected to see a similar low interest rate environment in the medium-term, down 1.5% immediately after Carney’s statement was published.

For the same reason, bond markets also retreated with 10-year gilt rates falling rapidly from 2.42% to 2.32%. Investors have been filing out of fixed income since Carney’s US equivalent, the Federal Reserve’s Ben Bernanke, mentioned he would seek to taper quantitative easing as the US economy continues to show signs of improvement.

The prospect of continued low interest rates and less quantitative easing means more investors are going to be seeking returns. This should result in greater flow into equity markets and there are already signs that volumes in both the UK and Europe are increasing.

While corporates may struggle to raise finance through bonds, improved liquidity in the equity market may help them to raise equity funding. Many are also expecting IPO markets to pick up in the medium-term, which is good for both businesses and markets.