Sunday, October 20, 2019
Can the next Bank governor avoid negative interest rates?
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

Is there a light at the end of the tunnel? Can we, for a time, focus on something else than Brexit? Yesterday’s vote in the House of Commons suggested that we may yet have to wait a while before sounding the all-clear, but the omens are better than they were, though the long-term implications of the prime minister's approach, discussed here last week, will still have to be taken into account.

In an election, which must come soon, the Tories will now be campaigning on their deal, the revised withdrawal agreement and what looks like a permanent “backstop” arrangement for Northern Ireland concluded with the EU last week, rather than a no-deal Brexit. The risk of the most destructive form of Brexit, crashing out without a deal, has diminished further. The government moved quite a lot in the last couple of weeks to avoid a no-deal Brexit and the EU moved a little. That is a good thing.

We analyse all this and the implications of yesterday’s parliamentary business, elsewhere in today’s paper. Let me instead focus on the possibility of other things happening once the Brexit logjam is cleared. Sajid Javid, the chancellor, has announced that should a deal with the EU be concluded, and that Britain leaves on October 31, his first budget will come less than a week later on November 6. We shall see.

The other aspect, which I wanted to concentrate on today, is the Bank of England. The Bank is awaiting the announcement of a new governor to replace Mark Carney, who may yet have a future in Canadian politics, and they should have known by now.

The chancellor has insisted that the process is on track to have a new governor in place by February 1 is “on track”, though that merely repeats the language used by Philip Hammond, his predecessor. He thought it best to leave the task to his successor. The complication for Javid is that, if there is to be an election, appointing the next governor ahead of a potential change of government could handing them a poisoned chalice.

I would love to be able to tell you today who the new governor is going to be. But most of the candidates have been keeping their heads down and, as far as I know, are as much in the dark as any of us. Most of the bookmakers who were taking bets on it appear to have lost interest.

One potential candidate who has raised her head above the parapet, the “superwoman” fund manager Helena Morrissey, wrote in the Spectator that a prerequisite for success is “a willingness to think about old problems in new ways”. I tried that one in an interview once.

She comes over as a bit of a devaluationist in hoping the Bank “will recognise the fantastic opportunity for export-led growth” offered by the pound’s referendum fall. As someone who has ploughed through more of the Bank’s analysis than I care to remember, I can confirm it has been looking very hard for such growth in the past three years.

Morrissey wants the new governor to be convinced that Britain has a bright future. Carney certainly did when he became governor in 2013, though his optimism has been tested more recently.

Perhaps most interestingly of all, Morrissey thinks the next governor should have no truck with negative interest rates. That is a hot topic among central bankers. One of the European Central Bank’s key interest rates, the deposit rate, has gone even more negative, at -0.5%. The Bank of Jpaan has had negative interest rates for some time.

And, while the chances of the Bank being forced into emergency action by a no-deal Brexit have faded, it is still the case that if and when the next recession comes, the Bank will go into it with much lower interest rates than in the past. The IMF has warned of a synchronised global downturn, and that this year's growth will be the weakest since 2009.

At 0.75%, Bank rate compares with 5.25% when the last recession struck, and 15% for the one before that. In both of those previous cases, the response was to cut official interest rates by roughly 5 percentage points. You do not need a calculator to work out that a similar response now would take interest rates into heavily negative territory.

A new collection of essays published by the National Institute of Economic and Social Research (NIESR), Renewing Our Monetary Vows: Open Letters to the Governor of the Bank of England, is therefore timely.

One, from Charlotta Groth, global macroeconomist with Zurich Insurance, sets out a series of actions the Bank could take to avoid being pushed into negative interest rates. They include more aggressive use of unconventional policies such as quantitative easing (QE), before that point is reached.

The Bank gets very exercised about suggestions that QE has increased inequality, which it has not. It as, as Groth points out, more ammunition at its disposal than other central banks; QE in Britain is equivalent to around 20% of gross domestic product (GDP), compared with 40% for the European Central Bank (ECB) and over 100% for the Bank of Japan and Swiss National Bank. But, while QE has focused on purchases of government bonds, gilts, future QE may need to include risk assets.

An even more radical suggestion, which some central bankers are attracted to, is avoiding ultra low and negative rates by targeting a higher rate of inflation. Richard Barwell of BNP Paribas and Tony Yates, a former Bank of England adviser, argue in their essay that “four is the new two” and that serious consideration should be given to raising the inflation target from 2% to 4%.

The original UK target, set in 1992, was 1% to 4%, they remind us, with a long-term aim of 2% or less. It has not been properly reviewed in more than a quarter of a century. Their most pressing argument for change is one that was not even considered in the early 1990s, a time when double-figure interest rates were the norm. This was that the so-called “zero lower bound”, and the question of whether official rates should ever go negative, would become an issue. Nobody believed then, or for that matter until 2008-9, that interest rates could ever go as low as they are now. “Raising the inflation target reduces the probability that the economy will arrive at the lower pound in the first place,” they write.

It would be a big step, and one that would have to be done in co-ordination with other countries. When the original target was introduced few believed the UK could meet it but it has, particulalr in the period since Bank independence in 1997, since which time inflation has averaged exactly 2%. Getting to 4% from current low inflation rate – 1.7% in Britain – would require an effort.

But these and other ideas provide food fro thought for the new governor. Whoever he or she may be.