Mr Carney Upsets the Markets (Again!)

July 15.  St. Swithin’s Day[i].  An ancient British folk-tale holds that if it rains today, that will set the weather for another 40 days.  As I have argued before, meteorology and economics have much in common.  Perhaps economists would be better forecasters if they just ignored the central bankers.

Dear old George is gone. (I tried to warn him this might happen.) And he’s probably already forgotten by the wonderful Great Unwashed who overwhelmingly voted LEAVE. But Mark still walks tall: frightening pensioners; jousting with parliamentary committees, and talking down the Pound. He carries no scintilla of self-doubt. Never underestimate the extraordinary sense of self-entitlement of a Goldman Sachs alumnus.

But Dr (to use his correct title) Mark Carney, Governor of the Bank of England, the UK central bank, recently spooked the markets with an improper use of auto-suggestion (the technique by which advertisers – and others – bury biases in the public psyche.) And not for the first time. During the EU referendum campaign, he was brazenly partisan. That is not necessarily reprehensible, if you believe that he was sincerely defending British interests, as he saw them. However, this conduct by a public servant is constitutionally questionable – as the estimable Jacob Rees-Mogg MP has implied.

The undisputed fact is that on 30 June Mr Carney said:

In my view, and I am not prejudging the views of the other independent MPC members, the economic outlook has deteriorated and some monetary policy easing will likely be required over the summer… The committee will make an initial assessment on 14 July and a full assessment complete with a new forecast will follow in the August Inflation Report. In August, we will also discuss further the range of instruments at our disposal.[ii]

As soon as these words passed his lips the Pound fell from 1.3425 to the US Dollar to 1.3275.

This was an unambiguous signal (to use the central bankers’ lingo) that the UK Sterling base rate would be cut on 14 July. And nothing that Mr Carney said subsequently disaffirmed that notion. And all the barrow boys and girls, red braces (suspenders, in American) flapping, went to work yesterday morning in that expectation.

Only to find that (you can do your Mr Bean face now, Mark) the Monetary Policy Committee (MPC) left the UK base rate unchanged at 0.5 percent – where it has languished since March 2009. That’s longer than Mr Cameron’s premiership. In fact, the MPC has met now nearly 90 times to reconfirm the 0.5 percent rate.

So the Governor, like the grand old Duke of York, marched his monetary army up the hill – and then marched them down again.

Let’s just recall (because even many of those who work in the City don’t know) how the UK monetary system actually works. Dr Carney, while head honcho of the whole shebang, sits on the MPC alongside eight other worthies, all of whose voices and votes are equal.  Five of the MPC members (including the Governor) are BoE staff and the other four are “external” appointees. The Governor is the only permanent member – so long as he remains in post. All other MPC members have fixed terms of office (usually three or sometimes five years). Since the MPC was first formed in May 1997, 38 people have served on it (32 men and six women), predominantly academic economists.

It now seems clear that Mr Carney was arguing for a cut in UK interest rates to 0.25 percent yesterday, but that his fellow MPC members did not concur. One of the BoE people on the MPC is Andy Haldane, named by Time magazine in 2014 as one of the world’s most influential people. It will be interesting to read the minutes of this meeting in due course.

During the EU referendum campaign the warriors of Project Fear put it about that rates would have to rise in the event of a vote for Brexit. In the event, not only is the Governor seeking to cut rates but the yield on the 10-year gilt actually fell to a record low of 0.743 percent on 06 July. This was because, given the market turmoil, gilts represent a safe haven asset class. So the government can raise new money for next-to-nothing.

As recently as May the smart money was betting on a rate rise sometime in 2018. This was on the basis of a robust growth outlook. Interest rate movements take one to two years to impact the real economy so decisions on rates hinge on expectations about future levels of inflation. Hence the key text over which the mandarins pour is the Bank’s quarterly Inflation Report. Since May, the growth outlook has worsened – although the Chinese GDP figures released this morning were moderately ahead of expectations.

The world of Alice in Wonderland economics, where savers get negligible returns on the nest-eggs, and where investment decisions are distorted by the prospect of returns which are not commensurate with risk, now seems set to continue indefinitely. Some economists argue that the regime of near-zero interest rates is purely a monetary phenomenon created by the priestly caste of central bankers. Others, like Martin Wolf of the Financial Times[iii], counter that, while monetary policy does indeed determine short-tern nominal interest rates, the real driver of long-term rates is the supply of savings relative to the demand for investment. The world economy is suffering from a glut of savings relative to investment opportunities. Of course, that is not much consolation to the nearly one third of our population who apparently have no savings at all.

Even before the financial crisis of 2007-08 real long-term interest rates were in protracted decline. Since then, the debt burdens carried in both the public and private sectors have acted to lower the equilibrium real rate of interest. We should probably consider ourselves lucky that we get any return on savings at all – if Mr Carney had got his way it could have been worse. No wonder one hears increasingly of what I call Family P2P – The Bank of Mum & Dad lending to young Johnny at a cool 6 percent…

The fact is that seven years of near-zero interest rates here – and 20-odd years in Japan – have not restored the economy to robust good health suggests that the policy does not work. The fundamental imbalances in the global economy – the US twin deficits, German and Chinese current account surpluses etc. – are not addressed by a zero interest rate policy.

Well, there’s no sign of rain where I am this morning so perhaps the British summer will not be a washout after all. And if I’m forced to choose between economists and weather people, I’ll go for the weather people.

[i] He was an Anglo-Saxon Bishop of Winchester who died around the year 862 AD.

[ii] As reported, for example, in the Guardian, available at: https://www.theguardian.com/business/2016/jun/30/interest-rate-cut-likely-brexit-bank-of-england-mark-carney

[iii] Negative rates are a symptom of our ills by Martin Wolf, Financial Times 13 April 2016.