Carney’s Escape Velocity Aim Brings Canadian Halo to BOESimon Kennedy
Mark Carney’s first six weeks as Bank of England governor will test his ability to turn activist rhetoric into policy reality as he seeks to accelerate the struggling U.K. economy to what he calls “escape velocity.”
Set to start in London on July 1, the Canadian-born Carney casts his first vote three days later on whether to expand the central bank’s bond buying. He then has a month to deliver a report on whether the bank should copy the Federal Reserve by publicly plotting a path for interest rates.
“Mark Carney will take a more radical approach to monetary policy,” said Neville Hill, head of European economics at Credit Suisse Group AG in London and a former U.K. Treasury official. “The Bank of England is going to focus on stimulating the economy more aggressively and more consistently under him,” said Hill.
He predicts the BOE, which already has a 375 billion-pound ($579 billion) target for bond purchases, will seek to introduce forward rate guidance in August and eventually start buying an additional 25 billion pounds of assets quarterly under Carney.
Goldman Sachs Group Inc. economist Kevin Daly told clients today that there’s a 60 percent chance Carney’s first meeting of the Monetary Policy Committee ends July 4 with the release of a statement on the outlook, breaking with the panel’s practice of typically only commenting when policy is changed. There’s a 35 percent chance of an immediate 25 billion pound increase in quantitative easing, Daly said in a report.
Potentially standing in Carney’s way are his new colleagues on the nine-member MPC, some of whom question the potency of more stimulus and the virtues of guidance. Economists at Credit Suisse and Citigroup Inc. predict he will prevail, while Societe Generale SA and UBS AG are more skeptical.
“I suspect he’ll be in a more expansionary direction but he’s got to take the committee with him,” Bank of Israel Governor Stanley Fischer said in a Bloomberg Television interview June 13. “Having a new face, a new set of arguments will have an impact.”
The first foreigner to run the Bank of England since its 17th-century creation, former Bank of Canada Governor Carney, 48, was appointed in November by Chancellor of the Exchequer George Osborne, who says he wants “monetary activism” to bolster an economy weighed down by budget cuts and the effects of the financial crisis.
Carney spent 15 years at Goldman Sachs, starting in London as an analyst in 1988 and later working in Tokyo, New York and Toronto, where he was managing director for investment banking. He arrives at the Bank of England striking an ambitious tone while saying he doesn’t want to prejudge the U.K. situation. He has resisted the notion that central banks lack fresh firepower, arguing they aren’t “maxed out” and can be flexible in meeting inflation goals.
He praises the Fed’s willingness to telegraph policy intentions and points to Japan’s 15-year deflation fight as an example of the consequences of “half measures.” He uses the “escape velocity” metaphor, borrowing from the case for stimulus that former Treasury Secretary Lawrence Summers made for the U.S.
Osborne paved the way for change by rewriting the bank’s mandate to give it more scope to overshoot its inflation goal and ordering it to consider Fed-style communications. He has asked Carney to outline a position when the BOE issues its next quarterly inflation outlook in August.
“More clarity about the future path of interest rates could help keep financial markets more stable,” Osborne said June 19.
Money markets already may be indicating a rate increase as soon as 2014 with short-sterling futures showing banks will increase the rate at which they lend to each other by more than 25 basis points in September 2014. This implies the central bank will follow suit and raise its benchmark for the first time in more than five years, according to Morgan Stanley.
Other than testifying before parliament, Carney has declined to comment at length on the U.K. before starting his new job. After his final speech as Bank of Canada governor May 21, he answered a question about BOE policies by saying “it would be totally inappropriate for me to make any judgment on what those decisions could be.”
The U.K. central bank hasn’t stinted on stimulus, even with inflation topping its 2 percent target for more than three years. Outgoing Governor Mervyn King, 65, cut the benchmark interest rate to a record low of 0.5 percent, introduced the gilt-buying strategy and created a program to ease credit.
The economy also is showing signs of life after dodging a triple-dip recession. Industrial production unexpectedly rose in April; purchasing-managers reports show services and manufacturing at their strongest since March 2012; and home sellers raised asking prices for a sixth consecutive month in June. Inflation accelerated to a 2.7 percent rate in May, limiting room for stimulus.
Still, the U.K.’s gross domestic product remains about 3 percent below its pre-crisis peak and unemployment is at 7.8 percent after rising as high as 8.4 percent in 2011.
Credit Suisse predicts policies under Carney will enable its so-called U.K. reflation basket of stocks to extend its 7 percent gain so far this year. The index includes stocks that stand to benefit from rising demand and a lower pound, such as Unilever Plc, Diageo Plc and Rolls-Royce Holdings Plc.
John Wraith, a fixed-income strategist at Bank of America Merrill Lynch in London, says Carney’s policies could help reduce yields on two-year and five-year gilts to 0.3 percent and 1 percent respectively from 0.48 percent and 1.54 percent today.
Carney’s initial week in office is too soon to expect an opening salvo as he chairs his first MPC meeting, said Charles Goodhart, one of the original committee members and an emeritus professor at the London School of Economics.
“We all have to learn the ropes so I would hope he would do as little as possible in July,” said Goodhart.
In London, Carney will have less sway than he was accustomed to at the Bank of Canada, where the governor alone is legally responsible for policy. At the BOE his vote carries the same weight as those of his eight colleagues.
“He doesn’t suffer fools gladly, but he likes the to-and-fro from well-thought-out debate, so working with capable people won’t be a problem for him,” said Mark Chandler, who worked with him at Goldman Sachs and is now head of fixed income at RBC Capital Markets in Toronto.
Under King the committee at its last five meetings voted 6-3 in favor of keeping its gilt-buying program at 375 billion pounds. King was among those outvoted as he endorsed a 25 billion-pound boost.
Those backing the status quo at the MPC’s June meeting argued the economy is improving, inflation is above its target and buying more gilts could prompt investors to take on too much risk, complicating the withdrawal of support, according to minutes released June 19. Meantime, King’s camp argued that the case for extra stimulus is “compelling” given that the outlook at home and abroad remains weak.
Carney may side with stimulus to keep sterling weak and gilt yields low as other central banks maintain support for their economies, said David Blanchflower, a former BOE policy maker. The June minutes said volatility in global markets “illustrated the likely effectiveness of asset purchases” to some members of the majority, suggesting they may be willing to switch votes, he said.
“A great deal is expected of him and he’s been appointed to shake things up,” said Blanchflower, who teaches at Dartmouth College in Hanover, New Hampshire.
He said the state of the economy means Carney may need to push for purchases of assets other than gilts to revive lending and get money to small companies.
The new governor also may take advantage of the Bank of England’s new bank regulatory powers, said Jens Larsen, an economist at RBC in London who once worked at the BOE. The central bank already has extended its Funding for Lending Scheme to give banks greater incentive to lend. It ultimately may be willing to take on more credit risk by helping small businesses or try to reinforce bank capital, he said.
Carney has been most vocal in signaling he may revamp the central bank’s communications to indicate how long it will hold its benchmark interest rate at 0.5 percent. Such signposting was pioneered by New Zealand’s central bank in the 1990s. The aim now would be to boost growth by guiding investors, companies and households to lower their interest-rate expectations and plan for faster inflation.
Carney used the approach at the Bank of Canada when he pledged in 2009 to keep its key rate at a record low until mid-2010 so long as the inflation outlook didn’t change. The Fed went a step further last December by introducing employment and inflation thresholds to govern when rates would be raised.
The strategy finds favor with Citigroup economist Michael Saunders in London, who predicts the Bank of England soon will commit to refrain from tightening policy until a trigger such as an unemployment rate of 6.5 percent to 7 percent is reached, unless the MPC forecasts inflation will reach 2.5 percent over one to two years or inflation expectations become destabilized.
Accommodating inflation higher than their 2 percent goal would enable officials to loosen monetary policy further, reassure markets that they will wait for the economy to pick up and correct those consumers who still expect rates to rise in the next year, he said.
“Carney will try to make sure the Bank of England is communicating more directly and clearly,” said Saunders. “That is important to achieve as the bank has not been that effective.”
Carney still may find it a tough sell, given that policy makers Martin Weale, Ben Broadbent and Paul Fisher have joined with the departing King in suggesting formal guidance may be misguided. King said today that signposting has always been a part of monetary policy.
“Forward guidance, particularly if it’s associated with thresholds, in the British context, does have problems,” Weale said in an April 18 interview. Adam Posen, who left the BOE last August and now runs the Peterson Institute for International Economics in Washington, says Canada’s markets often moved counter to the central bank’s guidance, which he calls “cheap talk.”
Among concerns critics raise: There are few signs that markets anticipate an imminent interest-rate increase, officials have many ways to inform investors and their credibility could be hurt if they renege on a pledge or it is misunderstood. It also may be harder to set thresholds than in the U.S. given that British inflation is already above target and some economists question whether unemployment is a good gauge of the economy’s health.
“The MPC will have a detailed analysis of this topic, but the members are all well-informed,” said Brian Hilliard, chief U.K. economist at Societe Generale in London. “Why should they change their minds, just because Mr. Carney presents the ideas in person?”
The result may be guidance that will “include a heavy dose of conditionality to satisfy other MPC members,” said Amit Kara, a former BOE economist now at UBS in London.
To Darren Williams, senior European economist at AllianceBernstein Holding LP in London, the likelihood is that Carney will win the day, albeit over time.
“We expect the conduct of monetary policy to change markedly under Carney’s stewardship,” said Williams. “The process will be more evolutionary than revolutionary.”