But, for top marks, in the medium term he will need to help promote growth over inflation, marking a welcome shift in the UK’s performance since the crisis. In the G7, only Italy, rated seven notches lower than the UK, has had a worse inflation/real growth trade-off since 2007.
In the near-term he will lack the luxury of growth, and see CPI inflation heading even higher – to 3.4 per cent year on year, versus February’s 2.8 per cent – by his first BoE Quarterly Inflation Report, in August. His first job will be writing to George Osborne, explaining why CPI is over 100 basis points above target.
So, to establish his anti-inflation credibility early on, Carney may prefer to delay most stimulus till later in the year, by when CPI [consumer price index] inflation should be back under 3 per cent on base-effect, after having risen to around 3.5 per cent.
Combining the Bank’s estimate with our own ‘policy looseness analysis,’ suggests a further £330bn in extra liquidity is needed if Carney wants to return policy to its extreme looseness of 2009 and 2011, when QE was last run.
If all this comes through QE, it would leave the Bank holding about two-thirds of conventional gilts outstanding. In practice, given concerns about SME [small and medium interprises] financing, it is likely to be in tandem with the funding for lending scheme.
While the following are possibilities, Carney’s initial changes may be more cosmetic than real. First, his preference for a “flexible approach” to inflation targeting, yet with no Fed-style dual mandate, suggests little meaningful deviation from the present. Other perhaps than supplementing it with the ‘forward guidance’ on rates he provided at the Bank of Canada. Even his initial suggestion to target nominal GDP has practical difficulties, given the frequent, later revisions to GDP estimates that are released only quarterly and with a one month lag. Targeting nominal GDP also provides little to re-balance the UK’s unfavourable mix of inflation and real growth.
More potent would be to expand QE to a range of private-sector assets, such as helping banks off-load their non performing loans (NPLs) from mortgage arrears. So far, though, Carney has paid only lip-service to it.
Meantime, he may tinker round the edges with communicative changes, such as re-drafting the quarterly inflation report, and offering monthly, post-MPC, rather than just quarterly, press conferences to explain policy.
What remains to be seen is whether he pushes for an amended inflation target – such as the new CPI (H) measure that more directly includes housing costs. Currently at 2.6 per cent [year to February], back-estimates to mid 2006 suggest it has averaged 22 basis points less than headline CPI inflation. So, applying a 2 per cent target to CPI (H) rather than headline CPI would equate to a slightly looser target.
One thing is for sure, Carney will want to maximise the benefit to banks by keeping the gilts curve steep. Forward guidance should put extra weight on UK rates and short yields, but Carney needs to avoid an obfuscation of the Bank’s commitment to low inflation, if long yields are also to stay down. Otherwise, he may have to draw even more heavily on QE.
Either way, his dovish comments, ‘flexible’ inflation targeting, and a stagnant economy, all point to further stimulus. To establish his anti-inflation credibility early on, most of that may not come until later in the year. Watch this space.
Neil Williams is chief economist of global government & inflation bonds at Hermes Fund Managers. The views expressed here are his own.