After more than 20 years, and 82 issues, Sir Mervyn King has delivered his last Inflation Report. The transparency and rationality of this innovation has been one of Britain’s most important gifts to the world in recent times, even if the UK has not actually been very good at controlling inflation itself since 2008. As its main architect and, in his own words, the UK’s “consistent monetary referee”, Sir Mervyn deserves great credit. I hope that, in retirement, he will receive it.
The economic message of today’s report is a familiar one. Inflation has been revised down so that it is shown to hit the 2 per cent target in two years’ time, and real GDP is forecast to recover gradually. Similar forecasts have proven too optimistic in the past, but this time there are clear indications that the Bank will be introducing new forms of policy easing in the next few months, which may underpin the economic recovery.
Following the astonishing arrival of Governor Kuroda in Japan, Mr Carney must be sorely tempted to follow suit in trying to jolt UK economic expectations towards a new equilibrium. He is likely to get plenty of encouragement in this from the chancellor, who emphasised in the Budget that “monetary activism” is a core part of his overall economic strategy.
The new Funding for Lending Scheme (FLS) announced today in the UK is a useful and sensible development. It directly attacks the important micro problem of inadequate lending to small and medium sized enterprises (SMEs). But it is unlikely to have large scale macro-economic effects.
The FLS was introduced last July to address the increase in the funding costs which British banks were incurring as a result of spill-overs from the eurozone crisis. This had increased lending rates on UK mortgages and corporate loans at a time when the monetary policy committee was trying very hard to ease overall monetary conditions in the UK. And the FLS was the chancellor’s main response last year to the charge that he was deaf to the needs of the real economy, and inflexible in his pursuit of austerity policies.
Almost a year later, the verdict on the FLS is that it has significantly reduced banks’ funding costs, with the benefits of that being mostly passed on to mortgage and company borrowers, but that it has had relatively little effect on overall bank lending to companies, especially to small and medium sized enterprises (SMEs).
Today’s extension to the FLS greatly increases the incentive for banks to skew their lending to SMEs by offering them larger overall access to subsidised funding if they do that. Every pound of SME lending in 2013 will contribute tenfold to the banks’ eligible total of subsidised FLS lending. In 2014, it will contribute fivefold.
Furthermore, today’s announcement extends the FLS by 12 months to the start of 2015, thus re-assuring banks that their access to cheap funding for new lending will not suddenly disappear early next year. The Chancellor also hopes that the new FLS will help to influence the IMF’s response to his overall economic approach when they visit the UK shortly. Read more
UK real GDP is still stuck some 5 per cent below its pre-crisis level, the worst record among the major economies, apart from Italy. Some of this is certainly due to the problems which the Coalition inherited. However, about half of the shortfall in UK growth in recent years, compared to that in the US, is due to the tightening of 5 per cent of GDP in fiscal policy since 2009/10.
The dominant criticism of the government from mainstream economists is, of course, that the poor performance of UK GDP is due to a shortfall in aggregate demand, which in turn is primarily due to these fiscal measures. The Chancellor’s reply is that the UK could have faced a fiscal crisis without his budgets. The fact that public debt is now forecast to rise to 85 per cent of GDP in 2017/18 suggests that his concerns are not easy to dismiss as scare-mongering. Read more
The sterling exchange rate has now declined by about 7 per cent this year, thus eliminating all of the rise which occurred when the euro crisis was in full flood in 2011-12. Investors are asking three main questions about the drop in sterling. When will it end? Will it succeed in boosting UK economic growth? And could it, conceivably, lead to a full blown sterling crisis? Read more
The markets were impacted yesterday by two very different sets of monetary policy minutes from the Fed and the Bank of England. In the case of the Fed, the worry is that the central bank is back-tracking on its commitment to maintain open-ended QE until the labour market has improved “substantially”. Meanwhile, at the Bank of England, the concern is that monetary policy might be too easy in the context of a declining exchange rate, and an inflation outlook that will exceed the official target for at least the next two years.
Although coming at the monetary policy problem from entirely different angles, these concerns have one thing in common. It has become increasingly difficult for both the Fed and the BoE to communicate their policy regime clearly to the markets in an environment where their policy committees have become openly split about the right stance to pursue in the months ahead. Read more
Mervyn King’s speech on UK economic policy on Tuesday has received relatively little attention, perhaps because he is in his last few months in the governor’s seat at the Bank of England. However, it is extremely interesting , both in its analysis of the UK’s current predicament and in its recommendations for future policy action.
It lays out a distinctive course of action, which is different from the Plan A adopted by the government and the Bank in 2010, and also different from the Keynesian alternative that Olivier Blanchard of the IMF seems to have recommended at Davos.
The King plan, tinged with both pessimism and realism, argues for a long-term fix, rather than a short-term dash for salvation. But while the fix will take a long time to work, it does have some important implications for the banks, and the exchange rate, in the near term. Read more
Canadian Central Bank governor Mark Carney has been appointed as Sir Mervyn King's successor. Getty
Congratulations and best wishes to Mark Carney. When he becomes governor of the Bank of England next June, he will assume one of the three or four most important roles in global finance.
In fact, it will be a role much broader than that of his immediate predecessors at the Bank, who have not been directly responsible either for microprudential supervision of financial entities, or for the macro-prudential supervision of the financial system as a whole. Under the new regulatory structure designed by Chancellor George Osborne, the new governor will now assume responsibility for both of these tasks, as well as for monetary policy. Read more
The UK coalition government has reached almost exactly the halfway point in its electoral term. Quite soon, it will be too late for it to change its economic approach in time for the results to be seen before it goes to the polls on May 7 2015. Whether the prime minister recognises it or not, he is therefore facing a major strategic choice. Should the government change tack, while there is still time?
The strategy chosen by chancellor George Osborne in 2010 was based on a more rapid tightening in budgetary policy than was adopted in most other developed economies. The chancellor knew that the Bank of England would aggressively ease monetary policy in support of his plan, and hoped that this would result in a sharp depreciation of the real exchange rate, though he did not say this in public.
As the IMF meetings close in Tokyo this weekend, it is obvious that governments are struggling to find the correct balance between controlling public debt, which now exceeds 110 per cent of GDP for the advanced economies, and boosting the rate of economic growth. The former objective requires more budgetary tightening, while the latter requires the opposite. Is there any way around this?
One radical option now being discussed is to cancel (or, in polite language, “restructure”) part of the government debt that has been acquired by the central banks as a consequence of quantitative easing (QE). After all, the government and the central bank are both firmly within the public sector, so a consolidated public sector balance sheet would net this debt out entirely. Read more
The growth rate of the global economy is experiencing its weakest patch since the “upswing” in the cycle began in 2009. Of course, it has never been much of an “upswing”, given the depth of the recession which followed the financial crisis at the end of 2008. Still, the big picture seemed to suggest that global GDP was slowly on the mend, if not at a pace which could reduce global unemployment very rapidly. Now, even that modest recovery seems to be at risk.
Markets have not been oblivious to this renewed round of easing: since the end of May, global equities have risen by 8 per cent and commodity prices have recently rebounded from their lows in spectacular fashion. Although ”shock and awe” from the central banks seems to have been replaced by a sense of rather tiresome routine, the impact of QE on market psychology has not entirely lost its traction.
That will only last, however, if the current global slowdown proves to be just another mid-year lull in a generally recovering world economy. So what are we to make of recent data? Read more
Gavyn Davies is a macroeconomist who is now chairman of Fulcrum Asset Management and co-founder of Prisma Capital Partners. He was the head of the global economics department at Goldman Sachs from 1987-2001, and was chairman of the BBC from 2001-2004.
He has also served as an economic policy adviser in No 10 Downing Street, an external adviser to the British Treasury, and as a visiting professor at the London School of Economics.
Gavyn Davies is an active investor and may have financial interests and holdings in any of the topics about which he writes. The views expressed are solely those of Mr Davies and in no way reflect the views of Prisma Capital Partners LP, Fulcrum Asset Management LLP, their respective affiliates or representatives. This material is not intended to provide, and should not be relied upon for, investment advice or recommendations. Readers are urged to seek professional advice before making any investments.