Has the Bank of England governor been caught bluffing on interest rates?

Mark Carney

It will probably be “no change” at the Bank of England this week, with policymakers expected to keep interest rates at their historic low again.

The monetary policy committee meets on Thursday and in all probability will sit on its hands for the 83rd straight month. Most likely the MPC will keep the base rate at 0.5% for the rest of the year.

Andy Haldane, the Bank’s chief economist, has said the central bank might be forced to cut rates if the global economy, brought low by China’s faltering manufacturing sector, keeps sliding backwards.

Just nine months ago it was all so different. Governor Mark Carney was warning City investors not to bet against a rate rise. His message was as much for Britain’s mortgage payers as it was the bankers. Don’t go on a spending binge with the proceeds of unnaturally low rates, he implied, higher borrowing costs are coming down the track.

A generous view of Carney’s speeches at the time would be that he understood the world economy was too weak to raise rates and the only way for him to overcome a sense of complacency among borrowers was to deliver a message that would, over time, be revealed as hollow, but did the trick at the time.

If it was a ploy, it was one he repeated in autumn when he almost derided Haldane’s concerns that the post-crash global economy was in difficulty and might need a cut in rates to boost investment and spending.

Wise heads nodded and muttered about Haldane’s alienation on the monetary policy committee. Carney’s voice was cool, and above all positive.

He was forced to change his stance in the new year when figures from China that were expected to show a bottoming out of its 18-month slowdown instead revealed a further descent. That triggered another collapse in commodities, for which China is the biggest market. Oil prices hit $27 per barrel, after starting 2014 above $115. Copper, zinc and steel have likewise tumbled in price.

This leaves Carney in the same position as every gambler who succeeds by luck and bluffing. You must ask yourself how long before someone twigs.

There were a handful in the City and the academic community who said the Bank’s forecasting was deeply flawed. Like James Bond in Casino Royale, they detected an opponent who was bluffing. Arch criminal Le Chiffre thinks he has everyone fooled, but a twitchy finger on his temple tells the MI6 agent his hand is weak.

Carney doesn’t twitch or stroke his ear when rattled. Yet he has been bluffing for so long it’s a wonder the British public still pays him any attention. All last year he told us that interest rates were going to rise sooner rather than later. And now he says the opposite.

He would say the facts changed. But have they really? Apart from the US, all major central banks have talked about coping with a deteriorating situation for at least the last year.

His defence can also count on the small group of economists who argue he was not bullish enough then and even now should just get on with lifting borrowing costs.

This group looks narrowly at the UK’s rising employment levels, rising wages (relative to zero inflation), healthy corporate profits and vigorous banking system and argues that the recovery is complete. Normal service from the Bank of England, in the form of higher interest rates, should now resume, they argue.

Yet this analysis ignores the outside world and the fact that around a third of Britain’s GDP relates to trade with the outside world. This has many knock-on effects, meaning the UK catches a cold when others sneeze. That metaphor once belonged to our relationship with the US, but now applies to Europe and East Asia, which has become the fulcrum of the world’s manufacturing.

This brings us back to Haldane’s point and the likelihood that the next change in policy is the announcement of a cut, not a rise.

The MPC could cut the base rate to zero, or even go further and charge depositors for parking their money in Threadneedle Street. That would put it in good company; the European Central Bank already imposes negative interest rates and since last week, so does the Japanese central bank.

Both the ECB in Frankfurt and Tokyo’s Bank of Japan aim to generate consumer and business demand with a costly disincentive to save. It is a message to domestic firms and shoppers alike to spend. It is also a message to foreign savers to take their money elsewhere, with the crucial side-effect that a fall in demand for the host currency will make its value fall.

That is the express aim of the Japanese move to negative interest rates and the disguised motive of Mario Draghi, the head of the ECB.

A lower value currency increases the cost of imports and domestic prices. This increase in inflation will counteract the drag on prices from falling oil prices. Most importantly, it also cuts the cost of exported goods, which should increase demand abroad, raise production and employment, wages and consumer demand.

If Japan and Europe have chosen this route to boost their domestic economies, who is Britain to stand aside? When we resisted currency depreciation in the five years ahead of the 2008 crash, the pound was almost worth $2 and hampered large areas of manufacturing industry.

Carney knows this. A sense of embarrassment will stop the MPC from cutting rates, but there will be plenty of hints to that effect. Carney will be bluffing again in his speeches when he talks about the possibility of following Draghi and his Tokyo counterpart, Haruhiko Kuroda. But bluffing is what he does best.

And all the time he will hope the cards are kind to him. He knows cutting rates will have only limited benefit and raising them risks choking off what recovery there is.

These are desperate times for central bankers. They are the guardians of prosperity.

Powered by Guardian.co.ukThis article was written by Phillip Inman Economics correspondent, for theguardian.com on Sunday 31st January 2016 15.30 Europe/Londonguardian.co.uk © Guardian News and Media Limited 2010

 

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