Methinks the King doth protest too much

To be honest, I think there is a lot of fuss about nothing with this scheme…

…I don’t think it affects anything very much…

…It’s a whole lot of fuss about nothing…

…I frankly am not very fussed about this one way or another…

Sir Mervyn King, November 14 2012

There was a moment half-way through the Bank of England’s Inflation Report press conference when I gave up writing down Sir Mervyn King’s protestations about the total and utter insignificance of the unexpected move to transfer £35bn from its balance sheet over to the Treasury – but the snippets above give you an idea.

It was an oddly unconvincing performance, by the standards of a man whose conviction and forcefulness have helped him dominate UK economic policy for a decade. If anything, we economic reporters left the Bank even more confused about precisely what is going on with UK monetary policy than when we entered.

First, a quick recap. In the course of its QE programme of electronically printing money and using it to buy assets, the Bank has amassed a sizeable portfolio (about £375bn worth) of UK government bonds. Those bonds pay interest, and indeed have become worth more than when the Bank bought them, so the Bank is currently nursing a sizeable profit as a result.

Last week, the Treasury took that money across to its own balance sheet. In one sense, it’s only good accounting: it’s what the Bank of Japan and Federal Reserve do, and this is money which would, at some point, be returned to the Treasury anyway – why leave it there doing nothing in the meantime?

However, the timing looks suspicious, coming as it does ahead of an Autumn Statement in which it will be difficult for George Osborne to meet his borrowing targets. After all, this influx of cash will help bring levels of total UK debt down – although probably not by enough to prevent the Chancellor from breaking one of his rules.

And if you were looking for reassurance from the Governor’s appearance today, I’m afraid you will have been disappointed. Not only did Sir Mervyn pepper his performance with protests that there is nothing amiss to this, he somehow managed to confuse the issue even more. In his comments, he acknowledged that for the purposes of its calculations, the Bank regarded the £35bn transfer as equivalent to gilt purchases of the same amount. In other words, all else being equal it equates to an extra £35bn of QE.

However, he then insisted that the Bank was still in complete control of monetary policy, as it could, if it wanted to, offset this quasi-QE (QQE?) by doing its own reverse QE, reducing the size of its balance sheet and taking some impetus out of the economy. To confuse matters even more, as Chris Giles of the FT pointed out [£], the Inflation Report still put the total QE amount at £375bn – not the £410-plus total amount implied by that cash transfer.

Sir Mervyn’s not-entirely helpful explanation? “The best way of describing these forecasts is that they are conditioned on the £375bn that the MPC has carried out plus the prospect over a very long time period of the flow of coupons minus the financing cost”.

Any clearer? I thought not.

And there are other questions: would the Bank have paused QE if it weren’t for this? Did the Bank really not make any plans for this? Wasn’t the way in which the Bank structured QE precisely supposed to leave the profits in-house rather than at the Treasury, to underline its independence?

But if you leave them aside for the moment and peer far enough through the phraseological fog, you can kind of see the point Sir Mervyn is making: the Bank still has the power to pull monetary levers as it wishes. On this basis it is still just as independent as before.

But, and this is my point rather than Sir Mervyn’s, there has nonetheless been an important change in dynamic.

Hitherto, the Bank was proactive in its pursuit of monetary policy. What Sir Mervyn described today is reactive – the MPC being forced to bounce its QE programme off the Treasury’s own quasi-monetary action.

Why does this matter? Because UK economic policy is, at present, being carried out on a bed of nitroglycerine.

The Bank of England is sitting on a stock of government bonds roughly equivalent to the value of the entire housing stock in Scotland and Northern Ireland. This is, with one important distinction, precisely what happened in Zimbabwe and Weimar Germany and led eventually to hyperinflation – and it’s significant that other central banks (notably the Fed) have shied away from buying exclusively government debt, cognisant of how it might look.

And yet Britain’s government bond rates are still below 2%. People are still willing to buy them.

The only reason they are still there is that investors believe that the Bank of England really is sitting on those bonds out of choice rather than because they’ve been forced to do so by the Treasury. As Sir Mervyn indicated in his speech in Cardiff last month, the worst thing the Bank could do is allow that line to be blurred.

This policy transferring cash to the Treasury doesn’t on its own transgress that independence. But in a way that’s beside the point. QE’s success has hinged on having someone in control at the Bank who is clearly, absolutely and convincingly independent of the Government. Independent Sir Mervyn certainly is, but he certainly wasn’t convincing today.

PS This issue is just one of the reasons why it is absolutely essential that Sir Mervyn’s successor is someone who is regarded as absolutely credible by the markets – but that’s a discussion for another day.

This article also appears on the Sky News website

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