Mark Carney joined the Bank of England heralded as a superman. While he’s revolutionized the three-century-old institution, there’s not much he can do to achieve a balanced recovery.
The BOE governor is set to address an international audience of business representatives tomorrow in Glasgow, with Britain struggling to entrench a revival in exports as business investment and consumers drive the U.K. economy.
The obstacles Carney faces are the sluggish euro-region economy and the drag of the strengthening pound. While European Central Bank President Mario Draghi is expanding stimulus, until Europe is ready to buy more from Britain the goal of a shift away from household spending may remain elusive.
“It’s in the lap of the gods and Mario Draghi as to whether the bank can get the economy to rebalance the way it wants,” said Richard Barwell, an economist at Royal Bank of Scotland Group Plc and a former BOE official. “We need much stronger domestic demand in the euro zone and there’s not much Carney can do about that. Given the choice between a beautifully balanced recovery that’s more tepid and the one they’ve got, they’ll take the one they’ve got.”
A manufacturing survey published today highlights the challenge. A pickup in order books to a 19-year high in the three months to July was driven by domestic business, the Confederation of British Industry said, citing its poll of 481 firms. An index of export orders was flat.
The U.K. economy expanded 0.8 percent in the second quarter, according to a survey of economists before the July 25 report. That would match the pace of the first three months of the year and mark the point at which Britain has completely made up the output lost during the financial crisis.
The report is a preliminary estimate and won’t include data on business investment, which jumped almost 11 percent in the first quarter from a year earlier, or net trade, which acted as drag on growth after exports climbed just 0.5 percent. Britain’s trade deficit stayed close to a record in May as manufacturers shipped fewer goods to EU nations, which buy half of all the British goods sold abroad.
“The U.K. economy is currently unbalanced internally and externally,” Carney said in his Mansion House speech to bankers and financiers in London last month. “Sustained borrowing from abroad to consume at home is hardly a recipe for a balanced and sustainable expansion.”
The BOE governor is set to speak at 12:45 p.m. tomorrow as part of a business conference organized by U.K. Trade and Investment in conjunction with the Commonwealth Games.
The pound’s strength hurts U.K. companies that get sales and profits from abroad and report in sterling. Britain’s currency has gained almost 11 percent in the past year, making it the best performer in a basket of 10 major currencies tracked by Bloomberg Correlation-Weighted Indexes, as an expanding economy spurred bets the BOE will increase borrowing costs as early as this year.
Burberry Group Plc and Associated British Foods Plc are among companies warning that the pound is eating into earnings. Business Secretary Vince Cable said this month that there’s a limit to how far firms can absorb the loss of competitiveness on world markets.
“With the appreciation of sterling, the near-term prospects aren’t particularly strong” for rebalancing, said Sam Hill, an economist at RBC Capital Markets in London. “In terms of the modest success with growing the contribution of net trade, that’s only going to be hampered by a more aggressive approach on interest rates,” because the pound would strengthen further, he said.
With the BOE shifting to a tighter policy stance, the job of rebalancing the economy may fall to Chancellor of the Exchequer George Osborne. The divergence with the euro region, where the ECB cut interest rates to a record low last month, has helped push sterling up more than 8 percent versus the euro in the past year. The currency touched 78.89 pence per euro on July 17, the strongest level since September 2012. It traded at 79 pence at 11:37 a.m. London time.
“The most appropriate U.K. policy to slow demand should come from more aggressive fiscal policy rather than monetary policy,” said Neville Hill, an economist at Credit Suisse in London. “Tightening policy will push up the currency and make the rebalancing even harder.”