Oops, It’s Worse Than We Thought

oops

A NEWLY ASSERTIVE MERVYN KING IS STANDING ON A RATHER SLIPPERY PLATFORM OBSERVES KATE AYLING

Just as the Eurozone countries seemed to have got some sort of a deal thrashed out on the Greek debt problem, the Bank of England Governor Mervyn King chose his moment to lob another brick into the slowly-settling millpond. In a submission on 25th October to the Treasury Committee on the Bank’s quantitative easing (QE) programme, the Governor told the assembled MPs that he had no confidence that his latest £75 billion round of money-printing would result in any growth of bank lending to UK businesses.

Well, maybe that’s a bit cruel. What Mr King actually said was that the £75 billion of new issues over the next four months might mean that new bank lending might not shrink as fast as it would have done if he’d simply sat on his hands and done nothing. So, on the clear understanding that things are getting less worse rather than more better, it seems like a good moment to review the situation.

“I think the [QE] action will make a difference to the amount of [bank] lending,”

“I think the [QE] action will make a difference to the amount of [bank] lending,” Mr King flannelled, “but it certainly doesn’t guarantee that lending to the real economy is positive……Only the banks are in a position to assess credit risks for SMEs [small and medium-sized enterprises]. What we have to do is to find ways of giving incentives to the existing banks in order to lend more.”

Political Separation

Aha, clarity beckons. It’s up to the government to set up the incentives that will get the banks lending, the Governor was saying– not the Bank of England itself. And up to a point, Mr King is on safe ground here.

For the last 15 years or so, the principle handed down from Downing Street has been that the Bank of England should be independent from government policy. And the corollary is that the Bank is generally expected to refrain from politically-loaded remarks that might derail the public’s confidence in its elected leaders.

To be fair, Mr King has been treading that line reasonably carefully. Back in early October, as the Conservative Party held its annual conference in Manchester, he waited dutifully until the conference was over before telling the BBC’s Stephanie Flanders – without too much obvious embarrassment – that the extent of the European crisis had been much worse than he’d hitherto imagined, and that it had knocked his own calculations about UK economic growth off track. That was why it had become necessary to announce the second £75 billion round of QE, in addition to the £200 billion that had already gone out in 2009.

Hurrying Slowly

But why hadn’t he taken earlier action to head off the slowdown, they demanded to know at his October 25 parliamentary grilling? Because the Bank’s monetary policy committee hadn’t been sure that this was the right response, he replied. There had been “a serious question of balance of risks” – which seemed to be a coded way of saying that inflationary pressures seemed likely to ease soon, and that QE might have upset a boat that was getting more stable by boosting inflation.

That, too, would be fair comment. The idea of quantitative easing is that the Bank of England effectively prints new money so that the government can use it to buy back its own pre-existing debt obligations. That in turn puts new liquidity into the banking system, and with average luck it should eventually mean that banks can step up their lending to business. The risk is that, like the coin-clippers of the Middle Ages, you create inflation every time that you turn five pound coins into six.

And perhaps this wouldn’t be such a great moment to push up the retail price index. New figures have shown that consumer price inflation surged to 5.2 per cent in September – almost a 20-year high, And that although the BoE is adamant that inflation will soon start falling, it’s still far too high for comfort.

On 19th October, a week before his address to the Treasury committee, Mr King had told a business meeting in Liverpool that the UK’s economic recovery was now “off track”, because, he said, “the problems in the euro area and the marked slowing in the world economy [had] lengthened the period over which a return to normality is likely”. What he didn’t say was that there’d been plenty of depressing news on the home front as well.

Early October had brought some rather belated news from the Office for National Statistics (ONS) that the UK economy had grown by only 0.1% between April and June – half of the 0.2% estimated previously. And rumours that the service sector was leading the way had been unexpectedly dampened by figures showing that its output had grown by only 0.2% in the quarter, down from an estimated 0.5%.

That, of course, had been ancient history by the time the news of the downgrades came out, so there was always room to hope that things might have improved in the interim. But unfortunately the most recent indicators hadn’t exactly been bursting with optimism either. The head of the British Retail Consortium, Stephen Robertson, had sent high street stores’ shares downward by declaring that the coming six months would be “characterised by very low levels of growth”, and that the industry faced “probably got another 18 months of real challenge.”

That was before Tesco reported a 0.5% fall in like-for-like sales during the first half of 2011. At which point Mothercare had lopped 36% off its share price by declaring a 10% fall in its third-quarter sales. Not good.

The Declining Inflation Theory

So where does Mr King get his confidence about declining inflation? Partly, it seems, from the belief that most of the inflationary factors in the consumer economy don’t stem from splurging consumption. Rocketing fuel prices, a weaker pound and – lest we forget – tax increases have hurt everybody, he has said. But if we strip out these external factors, we find that underlying inflation remains “subdued”.

We can safely infer from all this that he sincerely believes that energy prices won’t rise any further during the coming months, and that the pound will hold its own or perhaps even strengthen again the euro and the dollar now that the European currency has been repaired. The one thing we can positively forecast is that the one-off hit from last January’s VAT increase (from 17.5% to 20%) won’t be repeated. Or, in other words, that between 1.5 and 2 percentage points of today’s 5.2% inflation rate can indeed be stripped out.

A Turbulent Priest

Flies on the wall of George Osborne’s office must be hearing some pretty ripe language about the Bank of England Governor these days. The importunate Mr King has been a long time in coming out as an outspoken policy commentator, but his media tutor can be proud of his recent confident appearances. Whether his judgement has been as good as his presentational skills remains to be seen.