When the new Bank of England governor takes over this July, he will inherit the same turbulent economy, says Andrew Smith
Hand in hand with the arrival of spring (sort of) came an air of renewed optimism about the UK economy with sentiment improving and the equity market testing previous highs. How justified is this, and is there anything the incoming governor of the Bank of England, Mark Carney, can do that his predecessor couldn’t to nurture the recovery?
When the new Bank of England governor takes over this July, he will inherit the same turbulent economy, says Andrew Smith
Hand in hand with the arrival of spring (sort of) came an air of renewed optimism about the UK economy with sentiment improving and the equity market testing previous highs. How justified is this, and is there anything the incoming governor of the Bank of England, Mark Carney, can do that his predecessor couldn't to nurture the recovery?
In his swansong inflation report, the outgoing governor, Mervyn King, produced something of a rarity – good news. Growth forecasts were revised up, rather than down. Admittedly, the changes were small, with GDP now expected to rise by 1.1% this year, up from 0.9% previously, and 1.9% (up from 1.8%) in 2014. But this was the first time since as long ago as 2008 that the Bank's forecast revisions have been in a positive direction.
The upgrade came hard on the heels of better news about output in the first three months of the year, with a rise of 0.3% confounding fears that the UK was heading for a 'triple-dip'. Economists may argue about the underlying strength this signifies – but never mind the quality, feel the width. The recovery has to start somewhere.
And the good news has continued to outweigh the bad. While employment has slipped a little, retail spending was subdued around Easter, and bank lending remains worryingly weak. On the positive side the British Retail Consortium suggested a recovery in the shops in May, car sales are back to pre-crisis levels, house prices are accelerating and the trade deficit is narrowing.
Moreover, industrial surveys are coming in stronger across the board. The Markit purchasing managers' index for May suggested that the economy has moved up a gear with manufacturing, services and construction output simultaneously pointing up for the first time in a year – with new orders strengthening markedly too.
Strong headwinds
These positive signs are obviously welcome but it is still early days. The headwinds which have held back the recovery so far have not gone away. At home, households continue to struggle against the backdrop of high debt, falling real wages and austerity measures. Our main export market, Europe, continues to stagnate, even if the eurozone financial crisis has gone into abeyance. And many firms – although sitting on large cash reserves – are nervous about investing them.
Can anything be done if this year follows the pattern of 2011 and 2012, which also began with raised expectations, only to give way to disappointment as the year wore on? In the Budget, the Chancellor made much of the idea that 'monetary activism' could offset 'fiscal conservatism' and announced a revised remit for the Bank of England to coincide with the arrival of the new governor. The inflation target remains a CPI rate of 2%, but the Monetary Policy Committee has been granted more time to meet the target than the conventional two-year horizon, if delay can be expected to improve the growth trade-off.
There is also the expectation that the new governor could employ more 'unconventional measures'. Speculation is that these could include forward guidance on how long interest rates can be expected to remain low, as introduced recently by the US Fed, as well as the extension of quantitative easing through a resumption of gilt purchases or even by buying other assets.
However, it would be a mistake to think he will be bringing a magic wand. With nominal interest rates at rock bottom, the MPC fired its best shots a long time ago; 'unconventional measures' are called that precisely because they are untried, untested and uncertain. The best bet now may be to reduce real interest rates by persuading us that the MPC will tolerate higher inflation for an extended period and not remove the punch bowl by tightening policy as soon as the party re-starts. But with so much invested in establishing credibility in the first place, it may prove difficult to convince the markets that the central bank is now prepared to act 'irresponsibly'.
Indeed, Carney would first have to convince his eight fellow Committee members, the majority of whom have resisted Sir Mervyn's attempts to resume QE in recent months. If the recovery is in need of further monetary support later in the year, it is most likely to be by evolution, not revolution.
Andrew Smith, chief economist, KPMG