My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.
Two weeks ago I pointed out that, while there were a few reasons for the stock market’s strength, quantitative easing(QE) by central banks was the most important.
Sure enough, a hint that America’s QE programme may not continue at its present $85bn (£56bn) pace , from Ben Bernanke, the Federal Reserve chairman, sent markets tumbling, led by a 7% sell-off in Japan. We may not have seen the end of the equity rally, but it relies on central banks playing the accommodative game.
One question is what this means for the Bank of England and its new governor, Mark Carney, who will take the helm in just over a month’s time.
A few days ago the International Monetary Fund concluded its annual health check on Britain’s economy, its Article IV assessment, with recommendations that had something for everybody. As a medical verdict, it was less radical surgery and more that the patient could do with taking a bit more exercise to speed up growth.
So George Osborne will continue with his fiscal strategy, although with a further nod towards boosting infrastructure spending where possible. Bringing forward £10bn such spending, to start now, as the IMF wants, may be easier said than done.
Where the chancellor has no quibble with the IMF is on monetary policy. Responding to its report, he described his approach as “monetary activism, a credible fiscal plan and structural reform”.
The Bank of England, in other words, has to do the heavy lifting on growth, while his fiscal consolition cuts the budget deficit. Structural reform, such as changes in education, welfare and tax, aims to raise growth over the medium and longer term.
What more monetary activism can the Bank do under Carney? Bank rate has been 0.5% for more than four years and there has been £375bn of quantitative easing through purchases of gilts (British government bonds), equivalent to roughly a quarter of Britain’s annual gross domestic product.
The new governor has not given too many clues recently. His valedictory speech, called Canada Works, lauded the performance of the Canadian economy and contrasted his country’s successful monetary union with the eurozone’s travails.
It would be nice if, in five years, Carney could reflect on the British economy with such a glowing assessment, though I suspect five years at the Bank will imbue him with a little more caution.
One thing we are unlikely to get is a cut in interest rates. Paul Fisher, the Bank’s executive director for markets and a dovish member of the monetary policy committee (MPC), warned on Friday that a rate cut from the current low level could have “perverse” effects and might not boost demand.
That does not mean the Bank has no ammunition. According to the IMF: “In addition to considering further purchases of gilts, the Bank of England could provide assurance to households and investors that policy rates will be kept low until the recovery reaches full momentum.”
Its second recommendation, so-called forward guidance, is likely to be adopted. Carney used it Canada at the height of the financial crisis. There is a question about how useful it would be now, when the markets already think Bank rate will not rise above the present 0.5% level until late 2016.
What it might do, however, is prevent the markets from responding to stronger economic data (if and when it comes) by pricing in an early rise in interest rates. The role of the MPC could be to point out that as long as the economy is so far below where it should be - real per capita GDP is 6% below pre-crisis levels - there will be no question of rates rising. Savers will hate it, but it could be a useful tool.
What about more QE? There has been an assumption that when Carney rides into town, the result will be an aggressive expansion of the Bank’s already aggressive programme of asset purchases.
For those of us who think this policy has already gone further than it should have done, this has been a disturbing prospect. There has to come a time when QE is put on ice. At some stage, of course, it will have to be put into reverse, and the gilts sold back, though not for a while.
Fortunately, it may not be as easy for the new governor to press the stimulus button as he, the chancellor and IMF might like.
The first obstacle is the rest of the MPC. The minutes of is meeting this month show that while three MPC members voted for £25bn more QE, including Fisher and Sir Mervyn King, six did not.
They warned that further asset purchases “could contribute to an unwarranted narrowing in risk premia and complicate the transition to a more normal monetary stance at some point in the future” The MPC majority wants to see whether the Funding for Lending scheme will work and, as the quote shows, is worried that the more QE it does the harder it will be to return to normal policy settings.
There is a view in the Bank that when Carney comes, the MPC will not want to see him in a minority. What was acceptable for King, an Aston Villa fan whose time as governor is nearly over, would not be acceptable for the star Edmonoton Oilers enthusiast from across the Atlantic.
That may not mean, however, that the rest of the MPC bends to his wishes. He may find that, if the prevailing mood is still against more QE when he takes over, it is best to keep his powder dry for another day.
The second obstacle could come from the data. Though details of the first quarter GDP numbers were disappointing - 0.3% growth came in spite of falling exports and investment - there is an expectation thatt growth will accelerate, to 0.5% or 0.6%, in the second. The service sector gained momentum during the first quarter.
Would more QE be warranted in August if second quarter GDP shows growth of 0.5% or 0.6%, alongside continued above-target inflation? Probably not.
The third obstacle could be what is happening elsewhere. There is no prospect of the Bank of Japan scaling back its QE but if Bernanke’s hints are taken at face value, late summer could be the time when the Fed is starting to wind down its programme. It could look odd if Britain were re-starting its QE at the same time.
Nothing is set in stone. Markets are split on what the new governor will do, and views shift with every data release. But the easy assumption that the arrival of Careny will bring a big and immediate increase in QE, is not nearly as easy as it was.