Don't make it personal

Depending on your point of view, the decision by BoE Governor Carney to step down in June 2019 is either a one year extension of his term, having previously said he would leave in 2018, or he is leaving two years earlier than the mandated eight years. Either way, at least we have some clarity on where we stand ahead of the release of tomorrow's Inflation Report.

The whole affair does raise a number of issues regarding the role of central banks. For one thing, does it even matter whether Carney stays a year longer? His decision is based on the notion that the Brexit negotiations will be completed by that point and he will thus have steered the BoE through this critical period. That said, the hard work will only just be beginning. So whilst an extra year is welcome, in reality he probably only has a couple more years of any real authority. Once he enters the last year of his contract the markets will be less willing to hang onto his every word. Just ask Sir Alex Ferguson, who announced he would retire as Man United manager in 2002 but his team stopped listening to him and they underperformed as a result. And as we now know, Ferguson reversed his position and stayed for another 11 years.

Then there is the ongoing saga regarding the personification of central banking. Just over twenty years ago, central banks were secretive places where senior officials went out of their way to be anonymous. Alan Greenspan put a stop to that, of course. But the Fed has done just fine since he left. Indeed, Greenspan's reputation, which was such that Republican senator John McCain once remarked that he would like to  “prop him up and put a pair of dark glasses on him and keep him as long as we could," has since taken something of a beating.

Carney himself was hailed as the "rock star" central banker. But his decisions have been far from flawless and his forward guidance policy got off to a very shaky start, although he redeemed himself in many people's eyes with his conduct during the Brexit campaign. However, personification of policy issues is to miss the point. Central banks are not about one man (or woman). They are organisations with long institutional memories, staffed with competent people, and in theory it should be possible to find a few possible replacements from amongst the senior members of staff.

The media made a big thing of the extent to which Carney's reluctance to commit for the full eight years was the result of increasing conflict with the new administration. There may indeed be something to that. The Times reports today that he was "incensed by the criticism of the global elite ... because he saw it as an attack personally." There is no doubt that the government badly handled many economic issues at the Conservative Party conference last month. Thus Carney's extension, whilst not the full three years which the government undoubtedly wanted, represents a compromise which allows him to say he is not cutting and running during the worst of the Brexit negotiations. It also makes Carney look like a guy who hangs around when the going gets tough - no longer the unreliable boyfriend, as he was once memorably described - which is likely to serve him well in future.

Indeed, the small matter of his own personal ambitions may have played a role in all of this. A Canadian election is scheduled no later than October 2019 and Carney would then be well placed to return home to claim a senior political position, should he wish to pursue such a career as often claimed. He would also be well placed for a slot as head of the IMF once Christine Lagarde's term expires in 2021, with the horse trading likely to start well before that. These factors may have been the personal decisions which Carney was referring to when asked last week about his future as BoE Governor.

The big question is how crucial will Carney be to the UK's immediate economic future. There is no doubt that he is a big beast in the economic and political spheres in which he will have to operate. He is far from indispensable but for a government short of serious economic talent, he gives it some cover as it tries to figure out how to move forward on Brexit. Carney has demonstrated his willingness to stand up to preserve central bank independence. This may not be popular in certain sectors of government but it is what he is paid for. As it happens, I do believe that easy monetary policy is more of a hindrance than a help at this stage of the cycle. The difference between myself saying that, and Theresa May expressing the same sentiment, is that I am arguing for a change of the policy mix between fiscal and monetary. The PM made no such claims.

Whatever else Carney does over the next couple of years, the real fun will be watching him take on his Brexit critics. The likes of Jacob Rees-Mogg will undoubtedly be critical of Carney's decision to give the job another year but sniping is Rees-Mogg's default position. Ultimately Carney's position has become highly politicised thanks to the Brexit shenanigans and over the next couple of years that position is unlikely to change.

Time for a policy rethink?

There are few indications as yet that the UK real economy has taken a hit in the wake of the Brexit vote, but the release yesterday of a snap post-referendum consumer sentiment poll does not bode well. The GfK index collapsed by 8 points, the biggest monthly fall in 21 years. It is early days yet and the initial reaction might prove an over reaction. Nonetheless, it will give the Bank of England food for thought as it meets next week to set interest rates.

It really is a toss up as to whether rates are cut in July or August, but either way the Bank looks set to react with a rate cut over the summer as Governor Carney has already hinted. But in a keynote speech last week he pointed out that "monetary policy cannot immediately or fully offset the economic implications of a large, negative shock." Indeed, it is increasingly looking as though the BoE has little real ammunition left to counter the Brexit shock, with the policy rate already at all-time lows on data back to 1694.

I have long been of the view that the BoE missed a trick in not raising rates in 2014 when it became clear that the economy was recovering faster than anticipated and the unemployment rate was falling nicely. In some ways it is understandable that the MPC was hesitant: After all, members did not want to be accused of derailing the upswing which had taken ages to get going. But however sluggish the recovery, the economy was not facing the life-or-death problems which prevailed in 2009. For that reason it was becoming increasingly difficult to argue that interest rates needed to remain at these emergency levels, although perhaps a tight fiscal stance did restrict the BoE's room for manoeuvre.

Some good news is that the BoE has an instrument  which was not available in 2009 in the form of the banks' countercyclical capital buffer, which this week was lowered from 0.5% to 0%. In principle this will raise the lending capacity of the banking system by almost 9% of GDP. But this may not do much good if the private sector does not want to borrow, as BoE officials readily admit.

So the policy cupboard looks a little bare, unless the government does what it should have been doing all along, and relaxes the fiscal stance to take advantage of the lowest bond rates in history - rates which have surprisingly collapsed further after the referendum, with 10 year gilts yields now at less than 1%. The Chancellor has tried to argue over the last 6 years that austerity is the best way to get the economy back on its feet in the long-term. But one thing we perhaps learned from the Brexit vote is that the electorate is not buying that. It may be too late to turn back the referendum vote, but it still isn't too late to have a rethink on fiscal policy. The UK's near term fortunes may depend on it.

That's the way to do it

Although large chunks of the British institutional framework appear to have collapsed in the wake of the Brexit referendum result, the Bank of England can continue to hold its head high. Governor Mark Carney has offered leadership and a clarity of message which has been absent elsewhere. The irony is, of course, that Mr Carney is not even a Brit but he is showing the natives of his adopted country how crisis management should be conducted. He has obviously learned lessons from his predecessor, when Mervyn King was initially slow off the mark in identifying and then tackling the wave of problems which washed over the UK banking system in 2007-08, although he subsequently proved to be a very safe pair of hands. 

Indeed, the fact that the UK banking system has held up pretty well in the face of the Brexit uncertainty shock is partly the result of the system put in place during the latter phase of Mr King’s tenure. Where Mr Carney has scored has been his willingness to lead from the front: His presentation today of the Financial Stability Report was his third significant public appearance in the 12 days since the referendum. The tone of the FSR was cautious and highlighted many of the things which could go wrong. The BoE warned of the risks to the commercial real estate (CRE) sector which might be triggered by Brexit, noting that “foreign investors accounted for around 45% of the value of total transactions since 2009.  These inflows fell by almost 50% in the first quarter of 2016.” 

Right on cue, two more companies today announced they were suspending trading in property funds following yesterday’s announcement by Standard Life. It does appear that overseas investors are getting their money out while they can. The ban on withdrawals might appear dramatic but it reflects the fact that the funds can only repay investors by selling their property holdings, but since property is an illiquid asset this takes time. Whilst this might cause investors to panic with regard to their ability to get their money back, this is not like 2008, although it will cause jitters to ripple throughout the market. The BoE also points out that the collapse in the CRE sector could feed into the wider economy because property is often used as collateral to secure bank lending, and less collateral might result in a lower level of bank lending. In a bid to ensure that lending is not restricted by policy actions, the BoE announced it would reduce the bank countercyclical capital buffer (CCB) from 0.5% to 0% with immediate effect. In effect, the funds which banks otherwise would have been required to put away for a rainy day can now be used for lending purposes. It is now raining! 

But the BoE knows that it can only operate on the supply side of the credit market. As Mr Carney noted in a speech last week “one uncomfortable truth is that there are limits to what the Bank of England can do. In particular, monetary policy cannot immediately or fully offset the economic implications of a large, negative shock.  The future potential of this economy and its implications for jobs, real wages and wealth are not the gifts of monetary policymakers. These will be driven by much bigger decisions; by bigger plans that are being formulated by others.” 

The markets are taking their own view on UK prospects with the pound at 31-year lows against the US dollar. Despite the central bank’s best efforts, there exists a vacuum at the heart of policymaking. Until we have more clarity here, the pound is likely to remain under pressure. Still, it’s good news if any foreign tourists fancy a holiday break in the UK. The economy needs all the support it can get.

The economic costs of Nigel Farage

What is it with the current generation of political (so called) leaders? Following last week's abrogation by Boris Johnson of his responsibilities, UKIP leader Nigel Farage has today followed him into the political wilderness. The mass resignation of Brexiters smacks of a political movement that having achieved its aim of winning the referendum, has no idea of what it wants to do next. It is rather like watching a bunch of children who, having screamed at the top of their lungs to get what they want, suddenly decide they are no longer interested. Whilst I have no truck with the policies of Farage, surely he owes it to the Brexit camp to figure out how his plans should be implemented?

It seems not. For an alarmingly large number of Brexiters, the referendum itself was the prize. Like the bunch of screaming kids, they now have to leave it to the adults to clear up the mess they created. 

One of those who must wade into the mess is BoE governor Mark Carney who tomorrow will present the biannual Financial Stability Report. This will be the first official report on the health of UK banks since the referendum. Although we can expect the Bank to say that the measures it has put in place have held up well so far, there are significant downside risks. Today's news that Standard Life has suspended trading in its property fund is perhaps the first indication that investors are beginning to get cold feet regarding their UK investment strategy.

The UK economy is going to need all the help it can get in the weeks ahead. If the BoE does not cut rates next week, it will almost certainly do so in August. Just when you thought they could not fall below their already record lows, the referendum result has wrong-footed us all. And the bad news is that this puts further downward pressure on the investments which form the backbone of our pension income. One of these days Nigel, Boris et al might like to explain to those whose pension income they have effectively robbed, exactly what the economic benefits of Brexit are. I am struggling to figure it out.