What exactly did we learn from Mark Carney's first performance as future Bank of England Governor.
GROWTH & INFLATION
If he was less diplomatic, Mark Carney might have described the UK economy as a “basket case”.
Instead, he noted that GDP has “not expanded for two years, and that “the economic circumstances here are clearly exceptional”. Fixing the underlying problems are “unlikely to be either smooth or rapid”, he added, and employment may only pick up slowly.
Dire diagnosis aside, he offered a cure of sorts. More stimulus. “Unquestionably, when I come in there will be considerable slack in the economy,” he said, adding that there would be “room for considerable monetary stimulus”.
For the last four years, the phrase has been shorthand for quantitative easing (QE), but Mr Carney signalled he would be more inventive. In Canada, he pre-committed to low interest rates for a year come what may. More recently, the US guaranteed that rates will be low until unemployment falls to 6.5pc or inflation rises to 2.5pc. “In the UK today, there is a valid discussion to be had about the potential use of this tool,” he said.
More flexibility could be inserted into the Bank’s 2pc inflation target, too, he added. The UK aims to get inflation back to target within two years, but in Canada it can take three. Similar flexibility could be used in Britain to help support growth and jobs and stave off a longer term risk of deflation, he said. If that did not work, other undisclosed policy instruments such as the Bank’s Funding for Lending (FLS) cheap credit scheme could be chucked into the mix as well. In all, Mr Carney made it clear he would do whatever he could to drive growth while the recovery was weak even if it meant inflation was higher for longer.
Mr Carney may have sparked the debate about altering the Bank’s 2pc inflation target in a speech in December, but yesterday he tried to shut it down. Back then, he suggested considering moving to a growth mandate a nominal GDP target. “Its best prospect of success is in circumstances where the economy is in the state the UK is in,” he added yesterday. So, nominal GDP here we come?
No. Quite the opposite. Mr Carney said he believed a fully flexible 2pc inflation target that let the Bank take longer to get prices under control, was “the most effective monetary policy framework implemented thus far”. About nominal GDP targeting, he added: “My view is that I’m not convinced it is a risk worth taking.”
However, it is “important the policy framework is reviewed periodically”.
Mr Carney was lukewarm on QE, at best. “The work we have done at the Bank of Canada suggest the returns from QE have declined as the scale of the programme has increased,” he said. He added that there were costs “with all unconventional policies”, and that he would rather devise other policies than use QE to buy mortgage or small business debt to help particular sections of the economy.
A proper exit strategy from the £375bn programme needs to clearly set out and he said more work needed to be done to establish QE’s costs and benefits. “If more stimulus was needed, different channels could be used,” he concluded.
Senior bankers and investors have been hoping Mr Carney’s arrival would signal a change in the Bank’s approach to the banks. His performance yesterday will have dashed those hopes. The main gripe the industry has with the central bank now is a push to make them own up to as much as £60bn in hidden losses and strengthen their capital position appropriately. “The core of the banking system is not as strong as it needs to be,” he said, welcoming efforts to “ensure the core banks are transparently and adequately capitalised”. He added: “It is in the interest of everyone there is a speedy resolution of this issue.”
He refused to rule out breaking up the state-backed lenders, Royal Bank of Scotland and Lloyds Banking Group (LSE: LLOY.L - news) , in the interest of competition. And he even raised the prospect of a spat with George Osborne over financial reform, saying that he “agreed with the logic” of the Vickers recommendation that ring-fenced banks had higher and more robust leverage ratios. The Chancellor has watered down Vickers so it now only complies with the global standard that Mr Carney himself brought in. The Canadian’s support for tougher requirements will have come as a surprise.
There had been speculation that Mr Carney held political ambitions in Canada, which could have raised an issue about his independence. He laid those to rest, simply stating: “I do not have political ambitions.” He also stressed that he would not tolerate political interference. “I won’t be making a large number of comments as fiscal policy, so I won’t be expecting a large number of comments on monetary policy,” he said.
Mr Carney’s £874,000 annual package drew some criticism from MPs, but he defended it as “broadly equivalent to the [former] chief executive of the Financial Services Authority” and in line with the pay and pension deal of current Governor Sir Mervyn King.
Was the £250,000 housing allowance recognition of the fact that mortgages are so expensive? Labour MP Teresa Pearce asked. Mr Carney said it was “consistent with the arrangements for international executives who move for a period to this country in order to equalise their living standards”.
After all, he said: “I’m moving from one of the least expensive capital cities to one of the most expensive.”
Mr Carney is clearly going to open the Bank up to more scrutiny. Its forecasts, which have been less accurate than those of even small economic consultancies, will be made “transparent and better integrated with policy analysis”.
He favours the “oversight committee identifying issues it wants to review”, and he stressed his success reorganising the Bank of Canada while weeding out costs and improving customer and staff satisfaction.