Comment: Potential for fireworks at the Bank

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The Independent Online
Aconsensus view has quickly emerged in the City about the new Bank of England appointments. It is basically favourable and could be summarised as follows.

Eddie George will be perfectly all right as Governor. The financial markets would like to see three things happen over the next three or four years. They would like to see the Bank assume some measure of independence; they would like to see it use the levers it has recently been given by the Government to lean harder against inflation; and they would like to see it become less accident-prone. The first two would give stability to sterling and the gilt market; the third would reduce the danger of damage to the Bank spilling over into damage to the City's business interests. On all counts, Mr George would seem a safe pair of hands.

On the first, any additional power will be fed only slowly (and reluctantly) to the Bank, and Mr George will be politically skilled at taking whatever is offered. Therefore, not having an outsider with a reputation for independence is irrelevant: what is needed to build up independence is credibility in the markets rather than cussedness. On the second, there is no problem: the Governor-elect feels strongly about the need for price stability, and wants to use the powers the Bank has been given. On the third, only time will tell, but there is no reason to suppose the Bank would improve its competence any faster under an outsider.

As far as the deputy governorship is concerned, the City seems to be slightly puzzled, but not really worried. The puzzlement stems from a misreading of the purpose of the appointment. Many people have assumed that Rupert Pennant- Rea is being appointed to bring more economic expertise into the Bank. They note that while most aspects of the Economist's coverage are excellent, the main area of weakness is in its economic judgements, particularly on the British economy. It has actually been very wrong on that, and the City notices such things.


But in fact the job is not about economics: it is about management, for the Deputy Governor is the head of the line management chain, a sort of managing director of the Bank.

Inevitably many people in the Bank are less than thrilled at having an outsider thrust upon them, though Mr George himself is happy with the appointment. In fact Rupert Pennant-Rea is a very good manager: orderly, logical and good with people.

That, then, is the conventional wisdom: perfectly good appointments, but nothing to set the Thames on fire. It is certainly a much more enthusiastic greeting than that received by the present Governor when he got the job. But is the conventional wisdom right? Maybe not. Maybe the next four years could be rather more exciting than the market currently believes.

There are at least two reasons for expecting fireworks: one internal, the other external.

The internal reason is that the Government's finances are in their worst mess since the mid-Seventies. The borrowing requirement is at the outer limits of the credible, even assuming that the tax burden is increased over the next two or three years. The Bank is one year into a borrowing programme that in all probability, in four or five years, will double the national debt. That sort of increase has never happened before in peacetime.

The Bank is the Government's agent in selling the debt. This is slightly unusual in the industrial world, for in most countries the Treasury sells its debt direct, but it dates back to the founding of the Bank in 1694. The Government borrowed through the Bank because a private institution had greater credibility than the government of the day.

A problem for the Government is an opportunity for the Bank. The normal lever that the Bank has employed, usually gently and frequently too gently, to encourage governments to pursue fiscal responsibility, is the threat of a run on the pound. Now the Bank has a new one: the inability to sell gilts.

True, in the past the Government always managed to finance itself at some price. But that was either in wartime, or in a high-inflation environment, or when exchange controls still existed. The game may have changed. In the old days a rise in base rates could always restore confidence to sterling. But to do that the increase has to be credible: on Black Wednesday the two rises were not. It is perfectly plausible that a similar credibility gap could open up in the gilt market, given the size of the funding requirement. In any case the Bank has an amazingly powerful weapon. The slightest hint that the PSBR might be impossible to fund, tipped quietly into the gilt market, would cause sufficient mayhem to bring the Government to heel.


This would not be an act of disloyalty: the Bank's own credibility may well be at stake. The one thing worse than telling the Government that it may have difficulty funding the borrowing requirement, and then the advice leaking, would be for it to say that the deficit could be funded and then being proved wrong.

The external game is changing, too. As everyone has seen, now that monetary policy is no longer sub-contracted to the Bundesbank, there is some scope for the Bank to use its platform to develop a more independent line. The report on inflation is the lever, the Government's anti-inflation target the fulcrum. In the present circumstances, this looks quite positive - at least policy is tipped against inflation to a much greater extent than it was before.

What very few people have spotted is that the authorities are shooting at a moving target. France is making its central bank more independent; Japan has done the same; presumably Italy will have to. What we have now may, in absolute terms, be an improvement on what went before. But in relative terms, in three years' time we may have one of the least independent of the main central banks because the others have moved on.

Put these two points together and there is a recipe for pushing the Bank still further towards an independent status. It will not happen because the politicians want it. It will happen because the gilt market wants it, and because the institutions, casting around the world for the best fixed-interest market in which to place their funds, will want it too.