Tuesday, July 15, 2003
King of the Bank
Posted by David Smith at 03:46 PM
Category: David Smith' s magazine articles

After 10 years as Bank of England governor, and more than 40 as a Bank official, Sir Edward (“Eddie”) George retired at the end of June, handing over to Mervyn King, one of his two deputies.

What is the changeover likely to mean for interest rates? And is George, as the first governor of an independent Bank of England, handing over to somebody who will effectively be the last? Membership of the euro, which must be a possibility during King’s governorship, would mark the end of the Bank in its present form.

George served two terms, beginning in the summer of 1993. If you cast your mind back to that time it was a troubled one for the British economy and for monetary policy. The humiliation of Black Wednesday, September 16 1992, was still fresh in the memory. Sterling had been chucked out of the European exchange rate mechanism (ERM) and some of the blame for not defending the pound properly had been laid at the Bank’s door, most notably by its German counterpart, the Bundesbank.

A new monetary framework had been hastily put together by the time George took over, involving an inflation target (then a 1% to 4% range), a quarterly Bank inflation report and regular monthly interest rate meetings between the governor and the chancellor of the exchequer. These became known as the “Ken [Clarke] and Eddie show”, although they started life as meetings between Robin Leigh-Pemberton and Norman Lamont. “Robin and Norman” did not have quite the same ring to it.

These new arrangements were new in 1993 and nobody had too much faith in them. It was only a matter of time, it seemed, before the old inflationary problems reasserted themselves, not least as a result of sterling’s post-ERM dive.

It did not happen. Under George’s watch inflation averaged exactly 2.5%, the current target. Interest rates, with 15% still fresh in the memory when he took over, never rose above 7.5% in his 10 years as governor. The holy grail of monetary policy is to have economic growth exceeding inflation and that, by a small margin, is what was also achieved.

There were, of course, plenty of changes and challenges along the way, including the Barings’ collapse (the interesting thing about which was that it was allowed to fail), and the granting of independence by Gordon Brown to a surprised George in May 1997. There was a lot of tension surrounding that announcement. Brown’s team had made no secret of the fact in opposition that it did not favour retaining George as governor. He contemplated resignation when, soon after gaining the prize of independence, he was told by the chancellor that the Bank’s role of supervising the banking system was to be taken away and given to a new Financial Services Authority.

They overcame that, and most people would say independence has worked very well for the British economy, if not necessarily for manufacturing because of the associated, perhaps coincidental, strength of sterling. At his final Mansion House dinner in June, having not had to write a letter to the chancellor explaining why inflation had missed the target, George handed one over to Brown anyway. It contained just two words – “thank you”.

In six years’ of meetings as chairman of the Bank’s monetary policy committee (MPC), George was never outvoted once. On several occasions he used his casting vote to secure a 5-4 majority against a rate rise favoured by his more hawkish MPC colleagues.

One of those hawks was often King, the new governor. Bank-watchers will be studying the Bank’s discussions and votes very closely in the coming months to see whether the change of governor leads to a more hawkish approach, and thus higher interest rates, than under George. My prediction, at this early stage, is that there won’t be much in it but that King’s appointment, together with other changes in committee membership, will result in marginally higher rates than would otherwise have been the case.

One drum King will be beating is that of rebalancing the economy. He has already spoken of the need for consumer spending to grow at a slower rate in the coming years, and for the producing side of the economy to expand at a more rapid rate, benefiting industry. That means he will be keen the keep sterling at around its present levels against the euro, to the extent that the Bank is able to influence that. It should also mean the gradual disappearance of the two-tier economy.

All that could be wishful thinking. King’s point is that such a rebalancing has to occur at some stage, even if predicting exactly when is difficult. A new era has begun at the Bank, and it promises to be different from the old one.

What about the euro? King has tried to disown some remarks he made a couple of years ago, when he said it would need up to 300 years of data to be sure Britain was ready. The Bank has no interest in signing up but has to try to keep its opinions to itself. My guess is that King will maintain his predecessor’s sceptical tone.

From Industry magazine, July 2003

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