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The Bank has a new Governor but can even his push for growth turn the political tide?

July 1, 2013

Few central bankers have stepped foot in Threadneedle Street accompanied with such high expectations as Mark Carney.

The subdued image of Montagu Norman, whose tenure as Governor of the Bank of England extended virtually throughout the inter-war years, stands in stark contrast. Naturally that was a different era, but Mr Carney (as he now is) arrives with a reputation – not to mention salary and transfer fee – akin to that of a star centre-forward moving on from an unfashionable provincial club into the Premier League.

As European economies continue to stall, the real risk is that too much hope and expectation has been placed in Carney’s arrival in the six months since his appointment was announced. Predictably much of the coverage over his Treasury Select Committee appearance in February focused upon his bumper salary package – expect this to continue, especially if there is no sustained upturn in our economic fortunes.

I suspect in the key areas of interest rate policy and over quantitative easing the Carney regime will reflect a faithful continuation of the monetary policy we have had over the past few years rather than any change of pace as has been widely anticipated.

Indeed George Osborne was probably most attracted by the prospect of an incoming Governor prepared to maintain the ultra low interest rates we have had over the past four-and-a-half years along with a willingness to print more money as the main tool of monetary stimulus.

I have argued before that the notional independence of the Bank of England already stands open to question. For over forty consecutive months now its inflation target has been surpassed – this has come to pass as a consequence of political complicity between the Treasury (both pre- and post- May 2010) and the Bank. Whilst the economic case favouring this cause of action can be robustly made, it clearly flies in the face of an ‘independent’ Bank of England. This continues to damage its credibility.

However, as we approach the pre-election season, I can only imagine this complicity continuing. With the date of destiny with the voters soon upon us and growth at best spluttering, brave would be the governor who resists political pressure for a fillip timed for spring of 2015. With the Chancellor making clear that there will be no shift in fiscal policy, all rests on the Bank’s monetary arsenal – or what is left of it – to deliver the goods.

Yet while a combination of loose monetary and tight fiscal policy has usually seemed enough to jumpstart the British economy in past recessions, in the near five years since the financial crisis, a turbo-charged version of that strategy has merely kept us in a state of suspended animation. GDP still remains 2.5% below what it was immediately prior to the crash. Cheap mortgage credit seems to be the only uplift from the Funding for Lending initiative and will now be reinforced by Help to Buy, which surely risks reinflating the property bubble. In spite of a plunge in the value of sterling, our trade deficit is stubbornly high.

Unfortunately cheap money acts only to delay the sort of reform needed to address Britain’s flagging competitiveness. Both the private and public sectors remain hugely over-leveraged, with that debt the main driver of continued caution from businesses and households when it comes to spending and taking on fresh liabilities. Ideally Mr Carney would start sketching out an exit strategy that might tackle the structural roots of our economic sickness. However, since (perhaps understandably) there is neither the commercial appetite nor political nerve to allow the bankruptcies and repossessions that would help wipe the economy’s slate clean, passive restructuring (otherwise known as inflation) will be the order of the day. Whilst two decades ago, Carney’s native Canada and Sweden were able to turn around banking crises within three years that was in an era of rapid global growth. Such expansion is highly unlikely to assist this time.

Which is why I suspect kick-starting growth is unlikely to be the central challenge of Mr Carney’s tenure. Instead, it will be the prospect of diminished living standards as wages continue to stall and ‘gentle’ inflation continues to be used as a means of effective debt reduction. No wonder the Chancellor is encouraging the Bank to take on a broader remit beyond inflation-targeting, with new powers to target unemployment and aid growth. Mr Carney has also indicated that he wants to provide businesses and consumers with much better long term signals or ‘forward guidance’ about the economy, including how long low interest rates are likely to last (I suspect we can expect silence on the latter front this side of May 2015).

So as we look ahead at what a Carney governorship may bring, it would be safe to bet that we have not yet reached the road with monetary activism, always assuming that the recent turmoil in the bond markets is not a signal that the central bankers’ room for this sort of manoeuvre has come to an end. Furthermore, events at both RBS and the Co-op bank in recent weeks have shown that interference by the Bank of England and the Treasury, even in the affairs of notionally independent institutions, is endemic – a situation that will only intensify as the General Election approaches.

Anticipate a looser still position on interest rates and quantitative easing in a bid to ease further the value of the pound if growth continues to stall. Expect clearer communication and a more informal style masquerading as transparency from Threadneedle Street, await even toying with unconventional ways of stimulating the economy. The Bank will certainly continue to neglect to keep the lid on inflation. But if there is one thing that we should neither ask nor expect from the new man at Threadneedle Street, it is miracles.