The Hawks Are Not for Turning

The economy and inflation are what matters.
Photographer: Chris Ratcliffe/Bloomberg

Bank of England Governor Mark Carney will have to work harder to convince the hawks on the Monetary Policy Committee to leave rates on hold.

At Tuesday’s Financial Stability Report press conference, Carney clarified that monetary policy should be the last line of defense to tackle problems with financial stability. To that end, given that a post-referendum Armageddon was nowhere to be seen, the BOE raised capital requirements for lenders, and took measures to constrain certain areas of consumer credit (such as auto loans) that may be growing too fast. 

The question is, where does this leave interest rates? Three members of the MPC are angling for hikes, 1 believing their panel has waited too long in taking back the raft of stimulus measures it introduced last summer after the Brexit vote shock.

Outgoing MPC member Kristin Forbes raised concerns about such financial policy measures in her leaving speech last week. She argued that the availability of financial policy measures was one reason behind her colleagues' “failure to launch” and hike rates from near-zero levels. According to Oxford Economics' Martin Beck, “on that logic, the rise in the [countercyclical capital buffer] should go some way to dampening the hawkish shift recently seen among monetary policymakers.”

But these modest actions, if sensible in their own right, are unlikely to actually swing the hawks back into believing rates should still be left on hold.  (Leave aside for a moment that I and my Gadfly colleague Mark Gilbert argued last week that Carney is right to look through inflation and keep the key rate at 0.25 percent).

To start with, the new measures will not fully come into effect until 2019. While raising the CCB, a requirement that varies according to strains in funding conditions, may amount to a $14.5 billion capital demand, the long lead time banks will have to address this makes the change decidedly less onerous than might first appear. Indeed, the BOE is introducing a staggered approach to raising the buffer specifically in order to keep banks from tightening lending too much in response. 

But even so, that's not the main focus for the MPC. The performance of the real economy is far more important for figuring out where to set the bank rate. And, as has been widely reported, it's held up nicely since the referendum. So nicely, that inflation's edging to 3 percent (though to be fair the dive in the pound since the referendum is playing its part). 

The bulk of the stimulus poured in last year in response to the surprise Brexit referendum result is very much alive and kicking. The BOE’s Chief Economist, Andrew Haldane, noted the effect of this easing in his conversion last week into a rate hawk. He said the 25 basis point rate cut in August last year was just one quarter of the monetary stimulus added -- the extra 70 billion pounds ($89.5 billion) of QE forming the remainder.

That's in addition to the Term Funding Scheme to promote lending and give banks access to cheap funding -- the BOE says there's 65 billion pounds outstanding here, and the MPC will decide at its August policy meeting whether to extend the program past its February 2018 expiry date. 

Tuesday's financial policy tweaks do not come close to the wider impact of the monetary policy stimulus.

What MPC officials need to decide is whether the measures they pumped in last August to prevent a possible economic collapse have either done their job and should be swiftly reversed, or are still needed as wage growth weakens and Brexit looms. The hawks on the MPC are clearly in the former camp, and the latest financial stability measures should do little to change their mind.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
  1. This excludes Kristin Forbes, who will be leaving the MPC at the end of the month. 

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