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King Pressured to Honor ‘Deal’ as Cameron Delivers Austerity

Mervyn King, governor of the Bank of England
Mervyn King, governor of the Bank of England. Photographer: Andrew Harrer/Bloomberg

Bank of England Governor Mervyn King is under pressure to show just how far he’s willing to go to support Prime Minister David Cameron’s once-in-a-generation austerity drive.

Cameron, 44, has broken with the convention established by the previous Labour government and publicly put the onus on the Bank of England to shore up Britain’s economy. Finance minister George Osborne, 39, said as recently as yesterday that the central bank can “deploy monetary policy tools” to offset the budget squeeze he unveiled this week to cut half a million jobs.

That puts the spotlight on King, 62, as he presides over a running argument at the central bank on whether to expand bond purchases. With the governor having spent the past year lobbying Cameron to cut the deficit, he must now balance the government’s expectation for payback with the need to preserve the independence given to the bank by Gordon Brown in 1997.

“Mervyn basically pushed them toward a tighter fiscal consolidation,” said Rachel Lomax, a former Treasury official who served under King as Bank of England deputy governor from 2003 to 2008 and is now a director at HSBC Holdings Plc. “I’m sure he hasn’t said anything explicitly, but implicitly the promise is if it gets too rough we’ll do some more quantitative easing. That’s what I think the deal is.”

While Brown, 59, seldom mentioned monetary policy both as prime minister and in the preceding decade as finance minister, the coalition government has kept up a running commentary. Cameron said Oct. 11 that the central bank was best-placed to promote economic growth, and Business Secretary Vince Cable said Sept. 20 that an interest-rate increase “would be a problem.”

Monetary Activist

“I’ve always been, if you like, a fiscal conservative but a monetary activist,” Cameron said this month.

King said in early 2008 that it would be “foolish” for politicians to try to influence monetary policy. The financial crisis has nevertheless reshaped the relationship between the central bank, based in London’s eastern financial district, and the Treasury in Westminster.

At stake is the independence that King says helped foster the longest streak of uninterrupted economic growth in two centuries and low inflation in the decade before the crisis hit.

“It doesn’t mean that the BOE has become the East End branch of the Treasury,” said Neil Mackinnon, an economist at VTB Capital Inc. and a former Treasury official. “But the notion of strict independence has probably been eroded by the extraordinary developments that we’ve seen arising from the economic and financial crisis.”

Blurred Lines?

The bank has legal independence on setting monetary policy, though its asset program means its policies are now intertwined with government funding. The Bank of England’s 200 billion pounds ($315 billion) in bond purchases since March 2009 means it now controls around one fifth of U.K. gilts, making it the biggest single holder. The bank has also pledged to coordinate its market activities with the Treasury’s bond agency.

“The lines get very blurred,” George Magnus, senior economic adviser at UBS AG in London, said in an interview. “If the bank were ever in a position where it wanted to raise interest rates, because of inflation or the economy recovering, then the Treasury may actually have a view about that in terms of debt service costs. It becomes very fuzzy.”

Cameron’s comments coincide with a crossroads in central bank policy as it moves closer to buying more bonds. Minutes of the Oct. 7 meeting, published Oct. 20, showed “some” officials on the nine-member Monetary Policy Committee think it’s more likely that further stimulus “would become necessary.” Adam Posen voted to expand purchases, while Andrew Sentance kept up his campaign for an interest-rate increase.

The Bank of England’s benchmark is currently at a record low of 0.5 percent.

Subdued Gauges

With King signaling this week that “extremely subdued” inflation gauges might make more bond-buying necessary and government ministers hinting the economy needs aid, the bank may face a challenge in claiming it is acting alone if officials act at their next decision on Nov. 4.

Any move would come at a time when inflation has exceeded the government’s 3 percent upper limit for seven months. Robin Marshall, an economist at Smith and Williamson Investment Management in London, says that King seems less preoccupied by hitting the 2 percent inflation target given him by Brown than nursing growth during the Conservative-led government’s austerity drive.

“He’s now interpreting his mandate more broadly,” Marshall told Andrea Catherwood on Bloomberg Television. “It’s not just an inflation target, he sees it as sustaining demand management as well, sustaining demand if fiscal policy is going to be locked up over the next five years.”

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