Conflicting interests

George Osborne, the Chancellor won approval when in November 2012 he announced the appointment of Mark Carney as Governor of the Bank of England. Carney, the former Governor of the Bank of Canada, steered that country through the financial crisis, avoiding the extreme ructions experienced in the United States and Britain. When he took office at the Bank of England in July this year, his presence generated optimism and confidence. But now he faces a problem, and it is one partly of his own making.

In the months before his arrival at Threadneedle Street, a policy discussion began—what might the new Governor do? One of the ideas trailed was of nominal GDP targeting, which means that the Bank might in future allow a modicum of inflation back into the system if the economy is growing and the level of inflation is not too alarming. Much excitement attended this possible policy—which never happened. However, it did suggest that Carney was not a retiring, back-room type. Here was a Governor with new ideas.

The idea that stuck was that of forward guidance, where the Bank indicates its future intentions for interest rates, a device that has been used before by the US central bank. In his first piece of forward guidance, Carney said that interest rates would stay at close to zero—0.5 per cent—until unemployment had fallen to 7 per cent. His intention was to show that the Bank would keep trying to stimulate the economy until employment levels improved.

The complication for Carney is that the economy is starting to recover and though unemployment is declining, it is doing so only slowly. Growth, however, seems to be returning at a brisker pace, although the character of this growth is not yet entirely clear. Still, in October, the International Monetary Fund doubled its 2013 growth estimate for Britain to 1.4 per cent. The question for Carney is whether this growth will mean he has to raise rates sooner than his forward guidance suggested. If so markets would be left wondering whether they could trust future interest rate signals emitted by the Bank.

There is an additional problem—the housing boom. The government insists that there is no housing bubble in Britain, and also insists that its Help to Buy scheme, which helps people to buy their first home, is not inflating prices. Whether there is a bubble is a moot point, but prices are certainly high and consumers are carrying large amounts of mortgage debt—over £1 trillion. If Carney raises rates, millions of mortgage holders will experience a jump in their monthly mortgage bill—and no government would want that. The result is that Carney and the government are at cross purposes.

Carney also faces the question of when to slow down the Bank of England’s quantitative easing programme of injecting money into the economy. This is also a question that the Governor in waiting of the Federal Reserve Bank, Janet Yellen, will have to answer when she takes over from Ben Bernanke in January 2014.

Mark Carney finds himself in a tough spot. Growth and rising house prices suggest rates should rise, while employment levels suggest they should not. He has assured markets in his forward guidance that he will keep rates low. The question is whether he can keep that promise—and what the consequences would be if he should have to break it.