Carney Seeks ‘Escape Velocity’ as Head of Bank of EnglandSimon Kennedy and Jennifer Ryan
Mark Carney’s quest for “escape velocity” takes off in the U.K. this week.
Poised to be the first foreigner to run the Bank of England since its founding in 1694, he will address lawmakers on Feb. 7 in London, days after declaring central banks aren’t “maxed out” on what they can do to drive their economies. At the same time, the central bank’s Monetary Policy Committee will be meeting on the other side of the capital, and Carney’s future colleagues probably won’t add to their quantitative-easing program as inflation ties their hands.
The challenge for Carney, 47, and a new class of central bankers worldwide is resistance to their talk of monetary activism by officials and investors who say further stimulus may do more harm than good. Carney’s U.K. arrival in July could mark an early test case for how far policy makers can spur growth when support for action such as bond-buying is faltering and doubt surrounds other unconventional tools.
“Expectations for him are through the roof, but he’s absolutely got the right approach,” said David Blanchflower, a former Bank of England policy maker who now teaches at Dartmouth College in New Hampshire. “The question is how he’s going to convince other people.”
Governor of Canada’s central bank since 2008, Carney was appointed to the Bank of England position in November. He will take the helm as it gets responsibility for bank regulation and ensuring financial stability. He also must address the results of reviews criticizing the bank’s forecasting ability and management. With such demands, and London’s role as a financial hub also under threat from the Libor scandal, it’s been said the next governor will need to be like Superman.
Carney will testify before U.K. lawmakers five months before he succeeds Mervyn King, 64. Any comments on the British economy would come as the country flirts with an unprecedented triple-dip recession amid the tightest fiscal squeeze since World War II. Scope for further monetary stimulus still may be limited as inflation enters a fourth year above the central bank’s 2 percent target.
Under King, the bank cut its benchmark interest rate to a record-low 0.5 percent and started a bond-buying facility that had purchased 375 billion pounds ($591 billion) of assets by November. Officials now are monitoring a new credit-easing program, and their policy announcement this week probably won’t include additional bond purchases, according to 43 estimates in a Bloomberg News survey.
At their January meeting, some of the nine MPC members questioned the ability of quantitative easing to stoke demand and said their credibility could be jeopardized if inflation remains above target through 2013, according to the minutes.
Carney arrives having professed his faith in the power of monetary policy and hinting that he’s willing to consider new measures. If he can act, it would be bullish for U.K. stocks, according to Credit Suisse Group AG analysts led by London-based Andrew Garthwaite. Shares of companies with positive earnings momentum and exposure to the economic cycle -- including retailer Next Plc and homebuilder Persimmon Plc -- would be among the beneficiaries if Carney succeeds in encouraging expansion, they said in a Jan. 22 report.
Carney already has fueled “sterling-negative sentiment,” said Kit Juckes, head of foreign-exchange research at Societe Generale SA in London. Juckes anticipates the pound will weaken toward 90 pence per euro from about 86 pence yesterday.
Morgan Stanley fixed-income strategist Anthony O’Brien says Carney’s “more ‘open-minded’ approach to monetary policy” means the yield curve for U.K. government securities may steepen. U.K. inflation expectations as measured by the so-called break-even rate today rose to the highest in 21 months on speculation Carney will expand policy.
Carney’s activism was on display Jan. 26 at the World Economic Forum’s annual meeting in Davos, Switzerland, when he described how central banks worldwide have room for more stimulus through communications and other tools. He suggested economies like the U.K. that face budget cuts can be flexible in allowing interest rates to stay low even if inflation is above target.
“There continue to be monetary-policy options in all the major economies,” he said. The task for policy makers is to “achieve escape velocity.”
His remarks followed a December speech where he outlined the benefits of guiding investors on rates and even discussed the merits of switching to a gross-domestic-product target, although he denied having the U.K. in mind.
“People have been worrying about the effectiveness of QE, but Carney is saying that central banks aren’t done,” said Richard Barwell, an economist at Royal Bank of Scotland Group Plc in London and a former BOE official. “The problem for most of the MPC is that they don’t necessarily think they need to do more because inflation is too high, has been for quite some time and will remain high.”
Carney’s transatlantic move may mark the latest in a central-banking revolution toward leaders who sound and then act more aggressively than their predecessors. Mario Draghi, who replaced Jean-Claude Trichet at the European Central Bank in 2011, backed deeper interest-rate cuts and broader bond-buying.
At the Bank of Japan, Governor Masaaki Shirakawa’s departure allows Prime Minister Shinzo Abe to name a replacement who shares his zest for more activist monetary policy. Shirakawa said today he’ll bring forward his exit to March 19 from April 8, when his term finishes. A year from now, Janet Yellen, ranked by JPMorgan Chase & Co. as among the most dovish Federal Reserve officials, may be a candidate to replace Chairman Ben S. Bernanke atop the Fed when his second term expires.
In the U.K., King’s resistance to expanding QE beyond gilts prompted former policy maker Adam Posen to complain to the BOE’s supervisory board. King also rejected giving investors guidance on interest rates and hasn’t pushed for the government to alter its inflation mandate.
Prime Minister David Cameron’s commitment to austerity has limited the government’s capacity to stoke growth, fostering the perception that the central bank is “the only game in town,” even though monetary policy is “not a panacea,” King said on Jan. 22.
“Personally I’m sympathetic to arguments that there comes a point when there’s a limit to what monetary policy can do,” said Howard Davies, a former deputy governor of the Bank of England.
Carney still has room to act, said Kate Barker, another former policy maker. Among his immediate options is telling Chancellor of the Exchequer George Osborne that inflation will take longer to return to target and introducing the Canadian-style practice of guiding investors on how long interest rates may stay low.
A Carney-run Bank of England also could beef up existing programs, according to Simon Hayes, chief U.K. economist at Barclays Plc in London. He suggests there may be an effort to buy assets other than gilts, such as bank bonds, or to expand the Funding for Lending Scheme, aimed at boosting credit by allowing banks to borrow at cheaper rates.
To Simon Wells, a former central-bank economist now at HSBC Holdings Plc in London, the dilemma for Carney is whether the U.K. will respond to more monetary medicine. That’s because he’ll inherit an economy riven with structural weaknesses and a likely permanent loss of some output and productivity following the financial crisis. The upshot is stimulus may only boost inflation and promote “zombie companies” rather than growth.
“There may just not be that much spare capacity, and so being bolder may mean being riskier,” Wells said.
His argument has echoes within the central bank, which would have to justify stimulus after inflation held at 2.7 percent in December, the 37th consecutive month above target.
While some of the rise in prices can be blamed on energy costs and a decline in sterling, “much is probably a by-product of the painful adjustments our economy has been forced to make,” BOE Chief Economist Spencer Dale said Dec. 12. The New York-based Conference Board last month estimated U.K. labor productivity growth shrank 1.3 percent in 2012.
Still, colleague David Miles has pushed for more asset purchases. He says there’s a fair amount of slack in the economy, so it’s possible to spur demand and avoid a permanent falloff in hiring and output without further inflation.
Even if Carney does decide to act, he won’t be as free as he was in Canada, where the governor is legally mandated to set policy and relies on the consensual support of colleagues for decisions. At the Bank of England, he will have just one of nine votes on the policy panel, something he acknowledged Jan. 23 when he said he’ll ensure the committee structure works to its “full effect.”
The first test may come if Carney tries to persuade his new colleagues to embrace forward guidance as a way to restrain market borrowing costs. In April 2009, he pledged to keep Canada’s benchmark rate at a record low until mid-2010 so long as the inflation outlook didn’t change. More recently, the Fed has copied that playbook and in December fleshed it out to include thresholds for unemployment and inflation.
U.K. officials have resisted such telegraphing, with King and other policy makers arguing it would be wrong to lock in future decisions and saying it’s hard to commit nine people to agree on a policy path amid turnover on the MPC. Amit Kara, an economist at UBS AG in London, says the lower market interest rates resulting from signposting aren’t enough to compensate for potential reputational risk.
While Jens Larsen, an economist at RBC Capital Markets in London and another former BOE official, says Carney probably will secure some form of guidance, he calls the debate over whether to replace the inflation target with another goal, such as the level of GDP, “overdone.”
Carney kick-started that debate in December when he said a nominal GDP goal sometimes can have a “more powerful” effect when interest rates are around zero. The argument is that it allows the central bank to make up for lost output, implying policy will stay loose for longer.
Still, economists say such a goal could be confusing, hard to establish, ignite inflation expectations and be vulnerable to lagging and frequently revised data. Larsen says the bank’s new regulatory powers also will enable it to intervene enough in the financial sector to free up credit without changing focus.
What Carney may need most in his toolbox is the luck of global growth and a return of animal spirits among investors, said Barker, who is now an adviser to Credit Suisse.
“Timing is everything with jobs, and he may be very lucky,” she said. “If he comes at a good moment, where he can be a new man telling a slightly new story and people are in the mood to believe him, that will help have good expectational effects.”
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