The idea of Bank of England governor Mervyn King strutting his stuff at a rave defies the imagination.
However, his bank’s spectacular recent series of u-turns – first over whether Northern Rock should be bailed out and secondly over the future direction of UK interest rates – have invited comparisons between King and just such a dancer.
Jeremy Batstone-Carr, head of research at brokers Charles Stanley, recently wrote in a research note: “The bank has been forced into more about-turns than an exuberant dancer at a summer music festival and has now ended up in a knot, in a heap and on the floor.”
The implication is that, where previously the Bank of England was inclined to raise interest rates in a bid to trim inflation, the Northern Rock debacle has knocked it into a post-rave stupor, and that it is uncertain of which way to move next.
Ahead of last Thursday’s announcement that it was holding base rates at 5.75%, a number of City economists and the OECD were suggesting it should cut rates. Their belief was a sharp move now would help restore confidence and stave off a possible recession next year. But the pleas fell on deaf ears. Instead the bank now seems to be prone, bamboozled, unable to shift a muscle.
King and his colleagues on the Monetary Policy Committee were once believers in “moral hazard”. This meant they took the view that if bankers screwed up they should be forced to suffer the consequences; not be bailed out by the BoE. The view was that, by salvaging such failures, the central bank would only encourage other bankers and investors to take even greater risks.
In this view, King differed sharply from his counterparts at the US Federal Reserve and the European Central Bank, Ben Bernanke and Jean-Claude Trichet respectively. Both the Bernanke and Trichet have fewer qualms about helping out their friends on Wall Street and in the wider financial markets.
But Northern Rock forced King to become more like the Fed and ECB chiefs. As the crisis escalated, King had such high-minded notions beaten out of him by more pragmatic politicians.
Terrified that their economic legacy was going to end up in tatters Gordon Brown and Alistair Darling appear to have managed to twist the governor’s arm. Even though the Bank of England is supposed to have been an “independent” institution since 1997, King was seemingly forced to abandon his commitment to the notion of “moral hazard” — for the sake of a couple of political careers.
But is something similar now happening in the world of interest rates? Huge uncertainties have been created over the future of personal lending, with interest rates for mortgages, personal loans and credit cards now expected to soar because the inter-bank rate remains so stubbornly high and because the mortgage securitisation market is showing few signs of returning to normal.
Also, the outlook for the future of corporate lending still looks hugely uncertain, just because the credit crunch looks so reluctant to loosen its grip.
Cassandras are warning that unless these issues are addressed via a rapid monetary loosening by the Bank of England, the UK economy could plunge into recession next year. The trouble is Gordon Brown‘s boom would never have happened if there had not been a ready supply of cheap debt. That was its lifeblood. At the very least, economists fear economic growth will slow down to 2% next year, well below the former chancellor’s forecast of 2.75% to 3%.
That’s why in advance of last Thursday’s decision, there were so many heart-felt pleas for the BoE to reduce interest rates — including one from the OECD.
BoE slated for being slow to cut interest rates
Batstone-Carr said: “Developed market central banks need to act now, they need to act aggressively, they need to act decisively and they need to stand prepared to act again if necessary.” And Adrian Cooper, economic adviser to the Ernst & Young Item club said: “A cut would show that the Bank of England is at last responding with appropriate vigour to the risks to UK growth and consumer confidence.”
And in an interview with the Financial Times on Friday, published ahead of his maiden pre-Budget Report this Tuesday, even Darling admitted he the UK economy cannot be immune to the sub-prime crisis for ever. He said he expects UK growth to slow next year.
However these cries for help have fallen on deaf ears in Threadneedle Street. King and his colleagues on the MPC instead held interest rates at 5.75%. The excuse appears to be members think they need more time to weigh up the long-term damage of the credit crunch on growth and inflation. They may also feel that if they had taken the knife to interest rates on Thursday, it would have smacked of “hitting the panic button.” But I believe it was an opportunity missed.
Now King and his MPC colleagues need to swallow their pride and focus on a gradual monetary easing over the coming months to reduce the chances of recession. It’s going to be difficult to achieve without King being portrayed as Brown’s bitch. But one thing’s for certain King cannot afford just to return to the dance floor and move whichever way the music takes him.
This article was the main business comment article in Sunday Herald on 7 October 2007