Sunday, April 25, 2004
Bank's market man is ready for rate rises
Posted by David Smith at 08:59 AM
Category: David Smith's other articles

FOR those accustomed to the Bank of England's traditional, oak-panelled parlours, Paul Tucker's office is a revelation.

As befits the Bank's executive director responsible for markets, he sits in modern surroundings in a recently refurbished bit of its Threadneedle Street headquarters, next to a large dealing room indistinguishable from those in the City's top investment banks.

Tucker, 46, is responsible for the way the Bank implements policy in the money markets. Currency intervention, if ordered by the Treasury or carried out by the Bank off its own bat, comes under his control, as does management of the country's foreign-exchange reserves. He is responsible for "market intelligence" making sure the Bank knows what the markets are thinking, and that they understand what the Bank is doing.

On top of this, there is arguably his most important job. Since June 2002 he has been a member of the the Bank's monetary policy committee (MPC). This month the MPC's decision to hold the base rate at 4% split the City. Nearly half of its Bank-watchers expected a rate rise. The MPC was also split, although the 8-1 vote for no change was clear-cut.

So was he concerned about the uncertainty surrounding that decision? Tucker voted for no change.

"I didn't feel uncomfortable with the April decision," he said. "It weighed with me in March that had we done anything it would have been a complete surprise. It would have raised questions of what we were up to in a strategic sense.

"Surprises are not ruled out in my view. If the market gets it wrong, we should do what we think is right and then explain that. But surprising the market when we haven't got a credible explanation is something we should avoid."

Right now another uncertainty has emerged. Analysts, having priced in a rate rise from 4% to 4.25% when the MPC meets on May 5-6, were thrown into confusion by last week's figures showing that inflation on the new consumer prices index (CPI) has fallen to just 1.1%, well below the 2% target.

Tucker, while refusing to say explicitly how he intends to vote next month, played down the significance of the inflation number.

"No monthly data release in either direction carries such significant weight, and this is what we have been trying to get away from," he said. "We store it up, and think about it in the round at the end of each month. The CPI data will be in with a whole bundle of other stuff.

"In terms of policymaking, I don't think it's a big deal," he said. "In terms of the explanation, you have to do a little bit more to explain why that particular feature of the current environment doesn't have medium to long-term significance."

He also has a good idea of where interest rates are, or should be, heading. Britain's economy is growing above-trend. Despite weaker than expected first-quarter figures, the International Monetary Fund predicts 3.5% growth this year. As that growth comes through, interest rates will need to rise, he said, towards a "neutral" level.

"My own view is that at the current level, 4%, we are still stimulating the economy. It's important that people don't think of this [raising rates] as the act of putting a brake on the economy. It is meant to take the foot off the accelerator slightly. I think 4% remains stimulative.

"If the economy travels along the path most expect above-trend growth with not much capacity rates will edge up and at some point the question of where the neutral rate is will become more tangible."

So the Bank has embarked on a programme of steady interest-rate rises, with next month as the likely next one. But where does the process end? Where is the neutral rate at which the MPC might think it is no longer stimulating the economy?

Tucker's answer will strike some as hawkish. Some economists think only one more rate rise will be needed, while the money markets are discounting a steady rise to about 4.75%.

"I think it might be in the range 5% to 5.5%, although it could be a bit lower. But that has to be heavily qualified. I don't think one can have a precise number that is right in all circumstances."

Since joining the Bank in 1980, Tucker has been singled out as a high-flyer. In an institution known for its sharp intellects, he stands out as one of the sharpest, a strong candidate for future governor. Having spent time as principal private secretary to Robin Leigh-Pemberton, governor during the boom-bust of the late 1980s and early 1990s, he is aware of the pitfalls, particularly from the housing market.

"If any of us talk about house prices or debt, it doesn't mean we have become asset-price targeters. It is what this means for the outlook for inflation, not just the central projection but the risks around that.

"The longer the strength in the housing market is sustained, the more one has to ask whether the equilibrium level has moved up. On the other hand, the longer this rapid growth continues, the greater the risk of a correction at some stage. A number of us find ourselves wanting to back both horses. There is no great split on this."

The Bank, in other words, believes there are good reasons why higher house prices might be justified Tucker cites low inflation, high employment, greater mortgage competition and the fact that people no longer fear rates will go "sky-high". But this does not mean there is no danger of a bubble.

He sees other risks in the current environment. One is of a repeat of 1994, when the Federal Reserve hit bond markets hard by raising interest rates.

"The uncertainty comes from how at the moment of their own choosing the Fed begins to trundle back from 1% to wherever their neutral rate is, at a time when not only yields are low but spreads are low," he says. "Another risk is that with yields and spreads so low, borrowing costs for many entities around the world look very cheap, and those are the circumstances in which problems could accumulate if companies and people borrow a lot of money."

One dog that has not barked for the MPC is a sterling crisis. Before 1993, interest-rate hikes were typically forced by the currency markets. No longer.

"Typically what went on the in the past was that some piece of data would come out and the markets would think inflation was getting out of control and it was too late," he said. "So the exchange rate fell because they thought our inflation was going up relative to inflation overseas. As long as we do our job properly that source of volatility should be behind us."

For Tucker, such credibility in the markets has been hard-earned. And if he has his way, it will be kept.

From The Sunday Times, April 25 2004

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