Pantomime Villain? An uncomfortable 2017 beckons for Mark Carney and the Bank of England

Some people have a rather unusual idea of appropriate seasonal sentiment. Just as the House of Commons rose for the Christmas break, its Treasury Select Committee announced that it would be launching a New Year inquiry in to the character, effectiveness and consequences of monetary policy since the onset of the financial crisis. In effect, the low interest rates maintained over what is now almost a decade and the quantitative easing rounds initially pursued during the opening years of this period but again since August will be put under the political microscope. The Bank of England and Mark Carney, its Governor, will be obliged to defend itself against a wide array of ardent critics.
Those critics appear to include substantial if distinct sections of the Conservative Party. Theresa May raised eyebrows when she appeared to use her public platform to imply that the stance taken by the Bank had inflicted damage on those who saved and that this should be corrected. The Governor was clearly alarmed by this overt criticism and at one stage looked as if he might end his tenure in 2018 leaving a successor to deal with Brexit, a suggestion deemed so destabilising that 10 Downing Street relented and a compromise date for his departure of June 2019 was swiftly established. The hard core Brexit lobby within the parliamentary Conservative Party has never (and almost certainly never will) forgiven Mr Carney for the stance that he took during the referendum campaign and has since been critical that the reduction in interest rates and restoration of a £170 billion quantitative easing package issued during the Summer was unnecessary as the economy has held up well since then.
The Treasury Select Committee’s concerns are driven by rather more subtle and cerebral factors. These relatively specialist MPs are interested in questions such as: Has monetary policy in the UK only worked by raising asset prices artificially which is dangerous in itself but also widens the gap between those who hold assets such as property and equities and those who do not? Have ultra-low interest rates been the catalyst for the UK’s poor productivity performance because it has ensured that ‘zombie companies’ who should really be allowed to die have instead been kept alive but at the cost of dragging down the efficiency of the economy as a whole? Finally, has the maintenance of this form of monetary policy for such an extraordinarily lengthy duration merely sowed all the seeds for the next financial crisis while depleting the Bank of many of its resources to deal with that event?
This is tough stuff for the Governor to have to contemplate while consuming the Christmas turkey. He is also entitled to observe that these various critiques often seem to lack consistency or context. The Prime Minister appears to be suggesting that he has been harsh on savers (with implicit moral as well as economic misfortune as a result) while others are indicating that he has engineered an asset price bonanza whose beneficiaries would, logically, tend to be the sort of people who save. Keeping zombie companies alive is apparently bad but if he had pulled the plug on them all with a substantial rise in unemployment following as a consequence would he have been cheered to the rafters?
On Brexit, at least the Bank of England had engaged in some contingency planning in the event of a vote to leave, which is more than the Government as a whole managed to do as David Cameron all but banned thinking about such a possibility occurring never mind authorising a serious plan. That cupboard was so (deliberately) bare that if an alien had arrived in the BVCA offices between Mr Cameron’s resignation on 24 June and Mrs May succeeding him on 13 July and demanded “take me to your leader” then a trip to meet a Canadian in Threadneedle Street would have been rational. It is surely too early to conclude that the Bank’s dramatic intervention in monetary policy in August was unnecessary. It may have been of real value in shoring up the UK economy at an exposed time.
The Treasury Select Committee investigation will, nevertheless, be an extremely high profile event compounding what was already destined to be an extremely challenging year for the Governor.
Anticipating and responding to the direction of the economy in 2017 is extremely difficult
Even if all of the factors which influence the UK economy are domestic (a dubious assumption of which more below), and thus theoretically more or less under the control of HM Treasury and the Bank of England, then making an assessment as to what the direction of the economy will be and what to do in response is extremely complicated. A lot will depend on presentational and almost psychological factors surrounding the triggering of Article 50 of the Lisbon Treaty and the first stages of the negotiations over the UK’s departure from the European Union. This is very hard to anticipate. The consensus expectations for the economy (which have a high chance of being mistaken) are for lower overall growth (with a range of 1% to 1.5% widely cited) alongside much higher inflation as the impact of post-Brexit foreign exchange movements work their way in to the system (with a much more elastic set of options from 1.5% all the way to 4% being put forward by reputable people).
This alone offers the Monetary Policy Committee a dilemma. Slower growth, especially if were to be at the most meagre end of the spectrum, would normally be considered an argument for retaining low interest rates, even slicing them a tad to 0.1%, and contemplating further quantitative easing. Higher inflation, on the other hand, particularly if were at the most expansive end of the spectrum, would usually be deemed to be worthy evidence for the precisely opposite combination of policies.
International factors may well make the UK economy even more unpredictable
There are at least three macro-economic elements to the international economy that might well serve to make life for the Bank of England even more complicated. The most Delphic to discern is that of China where high debt and uncertainty over whether recent growth rates can be retained are a source of fundamental unease to economic analysts. While the immediate impact on the UK would be modest, a wider systemic shock would be unavoidable. The second is the health of the Eurozone and the credibility of the Euro itself in a year in which there are elections in France and Germany and where emerging, long supressed, unease about the Italian banking system could cause a much wider crisis of confidence in continental financial institutions on a scale similar to that of 2008-2009. The final total wild card is The Trump Factor. Although the US economy would appear to be operating at something quite close to full employment (albeit with historically very low real wages), the incoming Administration seems determined to apply a substantial fiscal stimulus via tax cuts and spending on infrastructure while at the same time taking a more aggressive stance on international trade issues.
The probable response of the Federal Reserve to Trumponomics will be a speedier shift to higher interest rates in order to prevent the economy overheating and inviting inflation in to the system. If this takes place at the same moment that the Eurozone economy stalls again amid widespread fears for the solvency of its key banks, then the Dollar is likely to appreciate against Sterling and run riot against an enfeebled Euro while Sterling could find itself to be a relative safe haven against the Euro. There would thus be inflationary pressures from the American-impacted end of the economy (with these compounded by oil being priced in the US currency) and deflationary pressures coming from the Eurozone-inspired end of the economy (still almost half of all UK exports). Working out what to do with that lot (and any turbulence in either direction from China) is truly Rubik’s Cube territory.
It is not often that one expresses sympathy for any man whom it is regularly suggested resembles George Clooney. Mr Carney in 2017 may be the exception to that rule. Happy New Year all round.