Old Lady, New Tricks? The Bank of England’s dilemma as it seeks to influence the economy
With more than six hectic weeks having passed since the EU Referendum on 23 June there are finally signs of a slowdown in the frantic pace of life at Whitehall and Westminster. Ministers are disappearing on holiday and while a lot of work will be occurring behind the scenes, not least in establishing the ‘pop-up’ Ministry for Brexit, public pronouncements will be relatively modest.
This week, attention has turned to the Bank of England which will announce its revised projections for economic growth and its decision on domestic interest rates tomorrow. It is now so widely expected that rates will be reduced that it would be a virtual sensation if that were not to happen. These are not, though, easy times for the Governor or the Monetary Policy Committee. They are the acid test as to whether the Old Lady of Threadneedle Street can adapt to spectacularly uncertain times.
The Carney paradox
It is somewhat ironic that Mark Carney finds himself in this situation at this stage of his tenure. His appointment as Governor occurred at the end of 2012 and he arrived in office six months later. It was a very unexpected choice with the then Deputy Governor Paul Tucker having been seen as the favourite for the succession.
George Osborne reached instead for Mr Carney because with the UK economy then cooling (growth in 2012 was all but flat) and the widespread fear that no recovery of note would be witnessed this side of the May 2015 election, the Chancellor wanted a figure at the Bank who would be willing to experiment with novel monetary methods that went beyond the £375 billion quantitative easing programme that had been introduced between 2009-2012 but which did not appear to be having a significant impact on the real economy. Mr Carney had made his name as the Governor of the Bank of Canada through an intellectual enthusiasm for innovation and it was his reputation to that end which led him to being selected ahead of internal (native-born) candidates.
Yet no sooner had Mr Carney arrived in London in July 2013 than evidence of the economy starting to accelerate accumulated. The experimentation which he was deemed uniquely qualified to impose on an otherwise unduly conservative institution was swiftly abandoned as unnecessary. He instead found himself cast in a much more orthodox light with a short-lived exercise in ‘forward guidance’, rapidly reconstituted after unemployment fell much more dramatically than predicted but without any indication of a surge in either inflation or inflationary expectations.
On at least two occasions, the Governor has publicly hinted that interest rates were poised to rise, only for him to retreat from that position due to changing circumstances (for example the oil price collapse in 2014/2015). The headline interest rate today – 0.5% – is exactly where it stood in July 2013. Indeed, it has not moved since March 2009. Bluntly, as matters worked out, Mr Osborne might as well have hired Mr Tucker.
It is only now, much later than expected, that a different Prime Minister and Chancellor are about to discover whether Mr Carney really is the post-modern hyper-imaginative Central Bank Governor that it was implied he would be when he was originally recruited. This intriguing test is to take place in political conditions which Mr Carney could not have imagined that he would be confronted with at the moment when he agreed to leave Ottawa for London, namely the need to assess the short-term and the medium-term impact of the UK leaving the European Union. This delay in having the chance to flex his intellectual muscles does, nonetheless, have a few advantages. He has had three years to exercise his own influence over the structure and culture of the Bank of England and so if he wants to chart a bold course he can be more confident of bringing the MPC and senior Bank staff with him.
What might the Governor do?
Mr Carney is unlikely to set out the whole of his strategy tomorrow. This would be a risky approach at the best of times but would be particularly risky for him at present. The truth is that the Bank has only a sketchy idea about how much the economy has and will ease as a consequence of the result on 23 June and has even less idea about how much of that impact is essentially psychological and how much it reflects economic fundamentals. There is the danger that Mr Carney could find himself a Corporal Jones Governor (borrowing from the Dads Army character) shouting “Don’t Panic” at the country and at the markers but in a manner that triggers far more concern that before he acted.
These include hinting that a further reduction to 0.1% before the end of 2016 is entirely plausible, or offering a new form of forward guidance to allow a sense of how long it might now be before UK rates reach 1%, never mind anything closer to what would have once been thought historically ‘normal’.
Yet, interest rates are so low already and the proportion of mortgages that are fixed-rate is so much higher than a decade ago that the notion of steering the economy via the base rate alone is improbable. The Bank will thus have to implement or show a serious contemplation towards either restarting quantitative easing of the previous form, or widening it to include corporate bonds or other financial instruments as well and/or expanding the Funding for Lending scheme, or even attempting some kind of ‘helicopter money’ endeavour. The UK may belatedly become, via Mr Carney, a truly unusual trend-setter in international economics.
The chances are that this would be welcomed at the Treasury and by the new Chancellor. For the simple truth is that the more radical that the Bank of England is prepared to be then the greater the flexibility that Philip Hammond will have as he decides how to ‘reset’ fiscal policy. He would have the option of being comparatively cautious in his Autumn Statement safe in the knowledge that the Bank was ready to bend the rules to support the economy or, if convinced that the economy in the near and longer-term required more substantial assistance, Mr Hammond could alter the direction of policy drastically, offering a much more expansive fiscal policy based around sizeable tax cuts not only to support the economy in 2016/2017 but to offer the vision of the UK as Europe’s Hong Kong. Lower interests over a longer term would also allow him additional flexibility in framing his strategy.
The international environment
Mr Carney’s dilemma as to how unorthodox he should be is not eased by the international economy. Signals here have been exceptionally confusing. In the US, surprisingly weak GDP growth data released at the end of last week may have pushed back consideration of a second interest rate rise to November or December rather than at the Federal Reserve Board’s September meeting.
The concerns about the condition of the Chinese economy which so spooked the international system at the outset of 2016 seem to have been calmed since but it would only take one set of adverse signals for there to be a repeat of the China-induced stock market slump seen last summer.
Growth in the Eurozone appears to have halved between the first and second quarters from 0.6% to 0.3% and France is stagnating. What the European Central Bank could or would do about this is contestable especially as Berlin is deeply concerned about the potential effects of negative interest rates on the economy.
Further, the Japanese Government will soon outline a(nother) new £200 billion spending package. Over the past few weeks it has been understandable that the news agenda here has been dominated by the sheer high-drama of elite politics. It might not be long before politics again takes a back seat to economics.
