Sunday, November 18, 2007
Despite headaches, King should stay
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


Has Mervyn King incurred the wrath of Gordon, and not just for missing his white tie and tails speech at the Guildhall last week? Do the mutterings in Whitehall and Westminster point to him being a one-term governor, unlike his three predecessors?

“There will be some difficult decisions in the months ahead,” said King last week. He meant on interest rates, but it also applies to something he is keen to play down – his own tenure.

Could he be like the Third Earl of Cromer, governor from 1961 to 1966, who decided not to seek a second term after a couple of years of dealing with Harold Wilson, another Labour prime minister who believed economics was his strong point? Has a decision, indeed, already been taken?

To take the last question first, no decision has yet been taken. The governor had planned to spend his summer holiday thinking about whether he wanted to serve for a second five-year term but the credit crisis got in the way. Not only did King fail to get his holiday but he says he has yet to sit down and think about his future.

That is why the reappointment decision has been put off until the new year. Some would say Gordon Brown and Alistair Darling are waiting to see what happens in the next few weeks.

King and his colleagues are due to give evidence to the Commons Treasury committee, probably early next month. Also in the coming weeks there is the thorny question of whether a way will finally be found to get Northern Rock and its lender-of-last-resort borrowings of more than £20 billion off the Bank’s hands.

That is going to take some time. The Bank’s best guess is that some kind of normality will return to the money markets by next summer, and the spread between three-month Libor (London interbank offered rate) and Bank rate will disappear. But we now know that the Treasury expects it to take a lot longer before the Bank waves goodbye to the Rock. We should not be surprised by this. Some of those bailed out by the Bank in the secondary banking crisis of 1973-4 stayed on its books for years.

There is also the small matter of whether another bank could succumb to difficulties. As Oscar Wilde might have said writing in this slot: To have a run on one bank is a misfortune; two might look like carelessness.

From King’s perspective the past few months have been difficult and demanding. The Bank has had its worst headlines for years and he has been the focus of a lot of public and private criticism, notably from the City. If he was even wavering about whether to carry on, this might have persuaded him to take his economics talents elsewhere, perhaps to a top American university, perhaps closer to home.

So should he stay or should he go? My strong belief is that he should stay. He should say he wants a second term and the government should have no hesitation in reappointing him.

Why? If King were to leave the job in the next few months – his term ends on June 30 next year – it would be seen as an admission of failure over Northern Rock.

Some things could have been done differently during the early weeks. The Bank’s lofty silence during August was a mistake, as King has admitted. Much of the subsequent criticism about u-turns and the Bank being “asleep at the wheel” emanated from a lack of clear explanation at the time.

There is a legitimate debate about whether, had the Bank been seen to be providing the liquidity the markets had been craving sooner, for longer than just overnight, the air of crisis could have been less. As it was, the Bank ended up providing much more of a liquidity injection (even excluding Northern Rock) than the European Central Bank but the ECB got the plaudits for its farsightedness and flexibility.

That is water under the bridge. King, who has thought about this more than most, will always maintain that nothing the Bank could have done in general assistance to the money markets could have saved Northern Rock from requiring specific help. Unless he is wrong about that, and I cannot see he is, it is hard to argue that the Bank could or should have done much different.

The bigger issue is the impact of the credit crisis and, at a time of conflicting pressures, the need to steer the economy through what will be a difficult period.

How difficult? The best way of assessing how much gloomier the Bank has become on growth is by comparing its August forecast on unchanged interest rates with the new one published last week.

At that time it expected growth to slow gradually, to a low of 2.5% in two years. Next year would see the economy growing by a still-strong 2.75%, which is why it thought another interest-rate hike would be needed.

Now, on that same basis, the Bank expects growth to slow to below 2% by mid 2008, before picking up to 2.75% in two years. The credit crisis, it seems, has knocked between 0.75 and a full percentage point off growth for next year. That is why the Bank’s main forecast is conditional on two or three rate cuts over the next year.

When will the first cut come? It is hard to reach a firm judgment until we have seen the minutes of the monetary policy committee’s meeting earlier this month. If it was a narrow 5-4 vote to hold, then a December cut would be firmly on the cards. If it was 8-1 or 7-2, I would stick to the view that February and the next inflation report is the most likely time.

But these things move quite quickly. My guess is that the Bank’s regional agents, who report on a monthly basis to the MPC, will have been quite downbeat. The committee has been waiting for the credit crisis to bite on the economy. That may now be happening.

Either way, this is no time for uncertainty at the top. King has been closely associated with the most successful period of UK economic management in the modern era. It is too soon to draw that era to a close.

PS: One of the great grudge matches in recent economic history was between Norman Lamont, former chancellor, and Helmut Schlesinger, former president of Germany’s powerful Bundesbank. In a day-long conference in the City to mark 15 years since Britain’s exit from Europe’s exchange rate mechanism, Lombard Street Research and the Churchill Archives Centre brought them together for a rematch, along with other luminaries.

Schlesinger recounted the now legendary meeting of European finance ministers and central bankers in Bath on September 5, 1992. Jane Austen-style gentility was cast aside as Lamont demanded three times that the Bundesbank president agree to cut interest rates, something that might have saved the pound from its Black Wednesday humiliation 11 days later. Schlesinger recalled that he was affronted and ready to walk out, until he had a conversation in German with Theo Waigel, then Germany’s finance minister. Waigel asked laconically whether Lamont was going to ask the question 10 times and the tension was defused.

It did not save the pound. Schlesinger was apologetic about the straw that broke sterling’s back – an interview he gave to the German newspaper Handelsblatt, suggesting other currencies than Italy’s lira might need to be devalued. It appeared two days before Black Wednesday and gave George Soros and his friends an excuse to dump the pound. Schlesinger said Handelsblatt broke the rules by publishing “unauthorised” comments.

Time heals. The conference was called The Turning Point. In autumn 1992 Lamont presided over a successful rebuilding of economic policy with an inflation target, followed by 15 years of noninflationary growth. When Schlesinger lost his footing last week, Lamont was first to rush to his aid. We should be grateful the Germans did not try to help the pound too much all those years ago.

From The Sunday Times, November 18 2007


Did the BoE end up providing liquidity after all? I thought that they held an auction, but by that time every other bank was so scared of being seen taking cash from the BoE that there were no bids. Meanwhile the ECB has injected hundreds of billions of euros, and continues to do so (115bn in the last few days being the latest apparently).

Posted by: Minh at November 18, 2007 10:22 AM

You're thinking of the term auctions, for which there was no take-up. When the Bank was concerned with keeping the overnight rate down, it provided plenty of liquidity, during both August and September. As I understand it, the ECB provided no net additional liquidity during August, for example, though many market participants concentrated on the daily announcements, which implied they were sloshing huge sums in. Most of that liquidity was overnight and additional liquidity at the start of the month was offset by smaller than usual provision at the end. This is from the ECB's November bulletin:

"In order to alleviate tensions in the money market in August and September, the ECB conducted a number of additional open-market operations with varying maturities of up to three months.
The additional operations changed the timing of liquidity provision within the maintenance period, as well as lengthening the maturity of the Eurosystem’s outstanding operations. It is
important to note that these operations did not change the total amount of liquidity provided in the respective reserve maintenance periods."

Posted by: David Smith at November 18, 2007 02:49 PM

Is there not a danger that the 'promised' rate cuts next year will quickly be factored in by the markets before the cuts actually are made? And that if eg only two cuts were made that this would be seen as a sign of fears about the stagflation which some commentators are predicting?

Posted by: John Rees at November 18, 2007 04:26 PM

(a) It is a bit daft to talk of stagflation with inflation at current levels
(b) If the Bank cuts by less or not at all it will probably be because growth has turned out stronger than it feared.

Posted by: David Smith at November 18, 2007 06:50 PM

Dear David,
Interest rate changes have been twice as frequent in Inflation Report months as in other months. Just a statistic, which might (or might not) be informative on what to expect in the forthcoming months.
With best wishes,

Posted by: cmilas at November 18, 2007 07:08 PM

Oh, ok, on overnight money the BoE defended their target rate, just as all the central banks did, and continue to do. The ECB might not have needed to do net-adds to defend theirs. But the biggest liquidity problems were in 3-month money, and King explicitly said the Bank wouldn't tamper there. By the time he changed his mind, and held the auction, there were no takers.

The ECB did some longer maturity operations, but you're probably right about net-adds - I don't have the data, but the press frequently misunderstand the way the system works. They are still doing so, in fact, with talk of the Fed injecting some $40bn or so on a single day. What they failed to mention was that there was a similar amount maturing on that day, so overall there was no net-adding of liquidity. The Slosh Report is a good resource for seeing what the Fed is up to - it's a pity there isn't a similar tool for the BoE/ECB.

From what I understood at the time, the Fed also went much further in relaxing their collateral requirements. They even said at one point they would take boat loans as collateral, although I don't know if they actually took any.

Posted by: Minh at November 19, 2007 01:01 PM

Of course he should stay. King is the only one who did the right thing in this whole fiasco.

As for where interest rates are going. Surely they should be held or even raised with inflation going berserk. Anyone notice food and petrol costs stagnating or falling recently? Thought not, and I don't expect this to change much over the short to mid term.

Posted by: Kev M at November 19, 2007 09:44 PM

Diesel now up over 10% in 2 months! Fact!
Food? At least up 5% in 2 months.

Life's essentials - who cares about ipods getting cheaper.

Posted by: Kev M at November 26, 2007 09:11 PM