Monday, May 05, 2003
All change at the Bank
Posted by David Smith at 09:04 PM
Category: David Smith' s magazine articles

The Bank of England, which has won many plaudits for its conduct of monetary policy since being given independence by Gordon Brown in May 1997, is about to face its biggest challenge.

Not only is the Bank about to have its biggest personnel shake-up since taking control of interest rates six years ago, but those changes come at a time when policy is moving into a tricky period.

First those changes in personnel. At the end of June, after serving the Bank for more than 40 years, and over a decade as governor, Sir Edward (Eddie George) will retire. He has seen it all during his period at the Bank, ranging from the great inflations of the 1970s and early 1980s, the unsuccessful attempt to keep Britain in the European exchange rate mechanism (ERM) in 1992, various banking crises, including BCCI and Barings, and the “Ken (Clarke) and Eddie show” – the quasi independence of the 1992-97 period that preceded the real thing.

It is hard to imagine the Bank without him. His successor, Mervyn King, is first to concede that George will be a very hard act to follow. King, however, has excellent credentials. As chief economist and then deputy governor he was responsible for creating the Bank’s quarterly inflation report, and for giving it a top-class reputation in economic analysis and forecasting.

When he succeeds George, his job as deputy governor will be taken by Rachel Lomax, most recently permanent secretary at the transport department, before that a leading light at the World Bank and the Treasury. When she joins, a third of the members of the nine-member monetary policy committee (MPC) will be women, along with external members Kate Barker and Marian Bell. That may not sound a particularly high proportion in this day and age but for the Bank, traditionally the most staid of institutions, it borders on revolution.

Lomax is not the only new face. Richard Lambert, ex-editor of the Financial Times, is also joining the MPC. If the quality of the Bank’s decision-making goes down from now on, some will undoubtedly blame the day that a journalist was allowed on board.

Apart from King, Lomax, Barker, Bell and Lambert, there will be four other members of the MPC, Sir Andrew Large, deputy governor with responsibility for financial stability, Charles Bean, the current chief economist, Paul Tucker, Bank executive director responsible for markets, and Steve Nickell, a London School of Economics professor.

There are two things to note about this team. Not all are economists. Although Lomax trained as an economist, most of her career has been as an administrator. Lambert does not even have an economics background, neither do Large or Tucker. A deliberate decision appears to have been taken by the chancellor, who is responsible for making or recommending the appointments, to balance a strongly economic governor, King, with non-economists.

The other point is that it is quite an inexperienced team. King will be the only survivor from May 1997, and the time when the Bank was granted independence. None of the rest were on the MPC before 2000 and, when the new committee is fully in place on July 1, five will have been members for less than 12 months.

Does it matter? After all, the Bank is generally agreed to have done a good job so far, keeping inflation very close to its 2.5% target and moving in quickly with interest rate cuts to head off trouble, notably in 1998 and in the wake of the terrorist attacks of September 11, 2001.

Right now, however, the Bank is up against it. Inflation has hit a five-year high of 3% at time of writing, even alongside quite a sharp slowdown in the economy. Many in the City expect the inflation rate to top 3.5% this summer, the level at which the governor has to write a public letter of explanation to the chancellor.

This may not sound like much of a sanction but it would, in effect, be a public admission of failure. If it came at the start of the King era as governor, the new man would have got off to an inauspicious start.

The problem for the MPC is that, while it is supposed to hit the inflation target at all times, monetary policy does not operate instantaneously. If inflation is high now, it reflects decisions taken 12 or 18 months ago, in other words those rate cuts after September 11.

Actually, the current inflation blip reflects two factors, housing and oil. Higher house prices and the rise in oil prices ahead of the war with Iraq were responsible for pushing inflation up. Oil is outside the Bank’s control, although housing is not – and one area where its economists have got it wrong is the housing market.

So should the new-look committee be raising interest rates? The difficulty is that if it did so, the governor could by this time next year find himself having to write a public letter of explanation for precisely the opposite reason, because inflation has dropped below its effective lower limit of 1.5%. This is because both factors that have pushed up inflation – housing and oil – are either going into reverse or are about to. If he is unlucky, the new governor could find himself having to write two letters, for opposite reasons.

He may be lucky. So far the inflation figures seem to have been on magic elastic, pulling back from the 3.5% or 1.5% inflation barriers just as it has seemed certain they would breach them. The MPC will be hoping the magic still works.

From Professional Investor, May 2003