June 22, 2017 / 9:35 PM / a year ago

COLUMN-Brexit blues means Haldane and Carney both right -Saft

(The opinions expressed here are those of the author, a columnist for Reuters.)

By James Saft

June 22 (Reuters) - Due to the dog’s dinner that is Brexit, Bank of England Governor Mark Carney and his chief economist, Andy Haldane, are both correct in their conflicting calls on interest rates.

Carney is correct; now is not the time to raise rates, and so is Haldane; a hike will be needed lest the BOE be forced to jerk rates rapidly higher.

Put succinctly; a weakening pound, potentially mounting current account difficulties and a slowing economy, all either due to or made worse by Brexit, mean that no monetary policy will allow the bank to meet its mandate of maintaining price stability while supporting growth and employment.

Brexit has put the BOE in an impossible position. What’s more, due to uncertainty over the negotiations and the shambolic state of Conservative policy, there is high uncertainty over the type of Brexit the economy will face.

Against this backdrop, the apparent contradictions between the governor and his chief economist melt, if not into insignificance, than into a something more recognizable: a tactical muddle.

Thus we have the prospect of a 4-4 split vote next month at the BOE policy meeting between hikers and those who would stand pat. Carney would then have the deciding vote, a drink out of the proverbial bitter cup.

Carney in his Mansion House speech before financial leaders on Tuesday both poked fun at Foreign Secretary Boris Johnson’s line that Brexit would result in “having our cake and eating it” while at the same time laying out his argument for keeping rates at 0.25 percent.

“From my perspective, given the mixed signals on consumer spending and business investment, and given the still subdued domestic inflationary pressures, in particular anemic wage growth, now is not yet the time to begin that adjustment,” Carney said.

More sobering was the list he then laid out of factors that might rescue the economy.

“In the coming months, I would like to see the extent to which weaker consumption growth is offset by other components of demand, whether wages begin to firm, and more generally, how the economy reacts to the prospect of tighter financial conditions and the reality of Brexit negotiations.”

None of those will be of much help. Investment will be further delayed by Brexit negotiations. Wages are unlikely to firm despite increased inflation. The economy will react to Brexit negotiations, and tighter financial conditions, with distress.


Haldane, speaking a day later, looks at the same data and comes to a seemingly different conclusion.

“If policy tightened ‘too late,’ this could result in a much steeper path of rate rises later, contrary to the MPC’s collective expectation that Bank Rate would increase ‘at a gradual pace and to a limited extent,’” Haldane said. He added that he saw withdrawing last year’s 25 bps point cut “relatively soon.”

The big risk here is a rapid sterling weakening driven by a deteriorating current account situation combined with a sudden lack of confidence as Brexit negotiations show up the UK’s true vulnerabilities.

Haldane may be worrying not just about inflation expectations shifting upward as inflation, already at a four-year high of 2.9 percent, pushes higher, but something more sudden and harder to control.

Carney spent much of the guts of his speech discussing the UK current account deficit, a section punctuated with the following warning:

“From the Lawson boom to the Tequila and Global Financial Crises, a common lesson is that large current account deficits are one of the most trenchant early warning signs of financial instability,” Carney said. “The UK relies on the kindness of strangers at a time when risks to trade, investment, and financial fragmentation have increased.”

Carl Weinberg, of High Frequency Economics, also notes the relationship between investment into the UK, funding the current account gap, much of which comes from the Middle East and Russia, and the price of oil. The latest downturn in energy prices, coming as Brexit negotiations begin, is badly timed and may cause an important source of capital to dry up at a very difficult time.

Haldane and Carney are thus both right, though not necessarily in agreement. A rate rise now would be destructive at a time of a consumer slowdown. We may well be discussing recession in Britain in several months.

At the same time, and this is especially true if Conservatives forge ahead with a “hard” Brexit, the BOE may want to begin raising rates soon, painful as that will be, to shore up the pound.

That may well not work, but that is the position, and not one the BOE made.

At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft Editing by Dan Grebler

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