1 Jul 2013

Carney: it’s going to be more than ‘open mouth operations’

This is George Osborne’s idea of a stimulus. Mark Carney reporting for duty – the 48 year old Canadian on his first day as Governor of the Bank of England.

Expectations are high – very high: that he will shake up these hallowed halls, and give the sluggish British economy a much needed boost.

His first task: a preparatory meeting of the committee that will vote on interest rates and extra quantitative easing in three days time.

The Deputy Governors, either side, Charlie Bean and Paul Tucker, lifelong Bank of England staffers who will leave within the year, have been voting against extra stimulus, outvoting Carney’s predecessor Sir Mervyn King. Which way will the new guy go? Can he allow himself to be outvoted?

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Mr Carney may have charm and a winning smile, but that can’t disguise the enormous problems he faces, especially in the area of debt. Total household debt in the UK is £1.4 trillion – built up in the boom years and little changed despite the crash. And total government debt is £1.2 trillion – and rising by £100 billion this year alone. Low long term interest rates are key to servicing these twn deficits.

The very first chart that Mr Carney was shown this morning at the monetary policy committee pre-meeting, was the spike in 10 year bond yields in the US and UK.  In the US this has arisen out of suggestions that Mark Carney is expected to mount what’s being called “open mouth operations”.

In other words, telling anyone who’ll listen that interest rates in Britain are staying exactly where they are for as long as possible. This forward guidance will help manage down longer term interest rates in gilt markets, and inject confidence into a business or house purchaser worried about rates going up.

The Old Bank of England did not go in for such expectations management. But it’s also looking like the changes might be more than just communication.

On August 7th we are expecting a report from the Bank of England indicating ways in which the Bank will allow itself to temporarily deviate from rigid inflation targeting. Specifically, to formalise ex ante the flexibility that has been evident ex post in inflation targeting.

Whatever happens, the Bank and the Treasury will claim that the commitment to eventually keeping inflation at 2 per cent remains sacrosanct. But leading City figures are now expecting a menu of options to be offered by the bank’s report on August 7th, and an immediate choice from this menu by George Osborne.

Nominal GDP targeting is thought to have communication problems. Unemployment threshold targeting is the hot favourite. Basically, a commitment will be made that interest rates will not go up until unemployment has fallen below, say, 6.5%. The Office of National Statistics recent GDP revisions help make the case: it shows that there is considerable spare capacity in the economy that is still 4% smaller than 2008 peak.

Essentially there is an answer to the following question: how does the Government maintain stimulus in an economy that may be recovering?  The answer is Mr Carney. And then there’s banking. More on that tomorrow.

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