UK Markets close in 8 hrs 14 mins

BoE Governor Hints At Monetary Policy Review

(c) Sky News 2013

The Bank of England Governor has opened the door to the first major overhaul of Britain's interest rate policy since Gordon Brown granted the central bank independence in 1997.

Sir Mervyn King has for the first time countenanced that the Treasury and bank should reconsider the system of inflation targeting which has been its main remit for more than two decades.

In a speech in Belfast, Sir Mervyn said that the remit, under which the bank is mandated to keep CPI (Other OTC: CPIC - news) inflation within a percentage point of 2%, had "come of age". 

He added: "It would be sensible to review the arrangements for setting monetary policy."

The comment is a marked departure for Sir Mervyn who, until now, had repeatedly denied that it was necessary to overhaul the system.

However, it comes amid growing speculation that the Chancellor may soon re-examine the mandate, particularly given that Sir Mervyn will be replaced by Bank of Canada Governor Mark Carney in July. 

Mr Carney is a vocal proponent of an alternative target, whereby the central bank would instead try to target so-called nominal GDP - the measure of economic growth which is not adjusted for inflation.

Sir Mervyn's comments will spark speculation that the Treasury is already considering such a shift. 

The question of what the bank targets is highly significant for UK economic policy, since it in turn determines how the bank would conduct monetary policy - the setting of interest rates and quantitative easing (QE).

There is evidence to suggest that if the bank had had a growth target it might have carried out more QE over the past year.  

Sir Mervyn pointedly did not mention so-called NGDP targeting in his speech, instead dwelling on the question of how much time and leeway the bank should have to try to get inflation back towards target.

However, with Mr Carney likely to be in the public eye in the coming weeks - appearing in Davos and then early next month testifying before the Treasury Select Committee in London - the question of a major remit overhaul will remain a live one.  

Sir Mervyn said: "How much discretion to give to the MPC (KOSDAQ: 050540.KQ - news) and how much should remain with the Chancellor is an interesting question that was raised, but not fully resolved, in 1997 with the system of open letters which gives the Chancellor the opportunity to comment on the horizon over which the MPC plans to bring inflation back to target.

"So there are certainly aspects of the inflation targeting regime to consider."

Sir Mervyn also warned of the prospect of so-called "currency wars", whereby central banks around the world attempt to devalue their exchange rates to secure better terms of trade.

Earlier today Japan's central bank adopted a higher inflation target, something some suspect is an attempt to bring the value of the yen down. 

Sir Mervyn said: "An increasing number of countries are coming to the view that only a lower real exchange rate will provide the stimulus to demand that their economies require.

"Several have taken action to achieve that end.

"That is a recipe for competitive depreciations, what some have called 'currency wars'. 

"Yet the existing configuration of exchange rates is unlikely to deliver stability.  

"For almost two decades the world has struggled with, but failed to resolve, this problem. 

"So it is hard to be optimistic about how easy it will be to manage the resulting tensions."