Carney Gets ‘Escape Velocity’ Mandate With Limiter: U.K. Credit
Incoming Bank of England Governor Mark Carney was handed scope to pursue “escape velocity” for the U.K. economy so long as it doesn’t come at the cost of surging inflation.
In a rewrite of the rules governing the central bank as a repeat recession looms and Carney prepares to replace Mervyn King in July, Chancellor of the Exchequer George Osborne yesterday twinned a rededication to 2 percent inflation with a call for “monetary activism” to revive economic growth.
Investors responded by pushing the pound higher against the dollar, yet also increasing bets inflation will accelerate as the U.K. 10-year breakeven rate rose to 3.28 percent. Even as Osborne resisted a more aggressive overhaul, Carney won room to justify overshooting inflation and was told to consider adopting Federal Reserve-style guidance on the likely length of easy monetary policy.
“The new remit is at face value not terribly different from the current one, but the devil is in the detail,” said David Tinsley, an economist at BNP Paribas SA who formerly worked at the Bank of England. “We are very comfortable with our long-held call that further monetary loosening in size is coming.”
The pound strengthened as much as 0.6 percent yesterday before easing to close little changed. It surged 0.5 percent to $1.5171 today after data showed U.K. retail sales rose more than forecast in February and the budget deficit narrowed. Sterling has fallen 6.7 this year, partly on speculation the Bank of England would do more to rally growth.
The 10-year breakeven rate, a gauge of inflation expectations derived from the difference in yield between regular and index-linked bonds, was at 3.27 percent today after climbing 1 basis point to 3.28 percent yesterday. It reached 3.37 percent on March 14, the highest in 4 1/2 years.
Geoffrey Yu, a senior currency strategist at UBS AG in London, said the pound rose yesterday as many investors “were positioned for even more aggressive measures” on the BOE’s remit. Still he said the changes may still “hurt sterling in the medium- to longer-term.”
Nick Eisinger, a sovereign analyst at Fidelity Investments, which oversees $1.6 trillion, shares that view.
“There will be more flexibility on the inflation target,” he said. “As this gets thrashed out and more details emerge, that may continue to be bearish for the pound.”
Policy makers are now likely to loosen policy through a number of channels with more quantitative easing, rate guidance and credit easing the early favorites, said Michael Saunders, chief western European economist at Citigroup Inc.
The refreshed mandate, which follows Carney’s appointment in November and his December triggering of a debate on the policy framework, avows the “primacy” of price stability and retains the 2 percent goal. Inflation climbed to 2.8 percent in February.
Osborne avoided greater aggression after the Treasury debated the merits of widening the target, monitoring other inflation measures or replacing it with a gross domestic product goal. In a review of the policy framework, it said aiming to achieve a set rate of nominal GDP growth could present communication challenges and leave inflation expectations less well-anchored. It rejected targeting other gauges of inflation as unlikely to add value over the status quo.
“It’s toward the lower end of what he could have done,” said Simon Wells, chief U.K. economist at HSBC Holdings Plc in London and former Bank of England official. “It’s not a game changer.”
Seeking to bolster an economy he now expects to grow just 0.6 percent this year -- half the pace forecast just three months -- and with little budgetary space to aid, Osborne blessed the BOE’s use of unconventional tools and said it could rationalize ignoring inflation in breach of the 2 percent aim. It must communicate the “trade-off” of doing so and outline an appropriate “horizon” for returning price growth to target.
While Osborne kept the inflation target, he will “consider the case” for a revision at every budget and make a decision “on its merits.” He also said officials are “actively considering” extending the Funding for Lending Scheme aimed at easing credit.
In a nod to where U.K. monetary policy may be headed, the chancellor said the central bank may wish to follow the lead of Canada and the U.S. in setting out guidance for how long policy could stay loose. He called for an August review of whether the BOE should mimic the U.S. by setting “intermediate thresholds” that will guide policy change.
The Fed in December tied its interest-rate outlook to unemployment and inflation, saying for the first time it will keep rates low “at least as long” as unemployment remains above 6.5 percent and if the Fed projects inflation of no more than 2.5 percent one or two years in the future.
The U.S. central bank said yesterday it will keep up its bond buying at a pace of $85 billion a month even as the world’s largest economy and the job market pick up. In a statement after a two-day meeting in Washington, it said labor-market conditions “have shown signs of improvement in recent months but the unemployment rate remains elevated.”
Carney, currently the governor of the Bank of Canada, has been an advocate of policy guidance, arguing Canada’s 2009 pledge to keep its benchmark at a record low until mid-2010 helped contain market borrowing costs without sacrificing inflation-fighting credibility.
“Forward guidance is Carney’s calling card,” said Robert Wood, an economist at Berenberg Bank in London and former Bank of England official. “We continue to expect forward rate guidance and more asset purchases after Carney takes over.”
By contrast, Richard Barwell, an economist at Royal Bank of Scotland Group Plc, who also once worked at the central bank, said more aggressive monetary policy may not do much for an economy beset by structural challenges such as weak lending and could end up fanning inflation.
“The bank is on the edge of what it can do,” he said. “A bit more quantitative easing is not going to guarantee a rally in output.”
U.K. officials have previously resisted telegraphing, arguing it would be wrong to lock in future decisions and saying it’s hard to commit the nine-member Monetary Policy Committee to a path when its composition regularly changes. The tactic also risks undermining a central bank’s credibility if it changes course sooner than anticipated.
Brian Hilliard, an economist at Societe Generale SA in London, said directing the BOE to study forward guidance also raises questions about its political independence.
A study last year by economists at the Federal Reserve Bank of San Francisco nevertheless said the Bank of England could have greater impact on bond yields if it better communicated the outlook for policy. It estimated about 60 percent of the recent decline in U.S. yields reflected lower expectations for future monetary policy, while saying none of the drop in U.K. yields was driven that way.
Current central bankers including Deputy Governor Charles Bean and colleagues Paul Tucker and Ian McCafferty have said the current U.K. framework is already flexible and allows it to look through temporary periods of above-target inflation to ensure stable output.
Such flexibility has been evident given the bank has continued to loosen policy even though inflation hasn’t been beneath 2 percent since November 2009 and reached as high as 5.2 percent in 2011.
The MPC has kept its key interest rate at a record low of 0.50 percent for four years, conducted 375 billion pounds of quantitative easing and tried to ease credit. It’s justified that stance on the grounds that the surge in inflation is due to energy prices, tax increases and the pound’s decline.
The dilemma of what to do next was evident yesterday in minutes of the Bank of England’s March policy meeting. While King again united with two colleagues in seeking a 25 billion- pound increase in quantitative easing, the majority of the MPC opposed more bond buying for fear it would erode their credibility and push the pound lower.
Carney has indicated he is open to easing, saying in January that central banks aren’t “maxed out” and should achieve “escape velocity” for their economies.
“With growth in short supply, central banks will have to overshoot on quantitative easing to make sure activity builds and inflation expectations are preserved,” said Neil Williams, chief economist at Hermes Fund Managers in London. “Because the alternative -- deflation expectations -- is unthinkable.”
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