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New rates body in UK off to a good star... |
New rates body in UK off to a good startFEW new British chancellors of the exchequer make history within four days of being assigned the stewardship of the treasury. But Gordon Brown did so last May after a tidal wave of support swept the Labour Party back into power, ending a generation of Conservative Party rule. Brown made his mark by the simple act of fulfilling Labour's election manifesto, which said: "We will reform the Bank of England to ensure that decision-making on monetary policy is more effective, open, accountable and free of short-term political manipulation." The chancellor said in line with his policy of achieving stability for long-term growth, the Bank would be given operational responsibility for setting interest rates to meet government inflation targets. Brown's announcement that short-term interest rates were to rise was the last time the news came from the treasury after the monthly meeting between Bank Governor Eddie George and the Chancellor. Henceforth decisions on the cost of money would be made by the new Monetary Policy Committee (MPC). It has nine members - all appointed by the government. Four, including the governor and his deputies, come from within the Bank, four are drawn from outside and the ninth, Treasury Permanent Secretary Sir Terence Burns, takes part in the monthly meetings but does not vote. Decisions are taken on the basis of a majority vote. If the voting is split equally, the governor has an additional casting vote - which was used for the first time last month when the MPC decided against hoisting interest rates. In this respect, Britain is finally following the United States, which has the Federal Open Market Committee, Germany, with the Bundesbank Council, and other Group of Seven economies. As Brown pointed out, the UK had been "one of the few major industrial nations in which the central bank does not have responsibility for decisions on interest rates. And our record on inflation and interest rates over recent years is poor, while countries with independent central banks have performed better". But the Bank's MPC has been made more transparent and accountable than most. The Conservative government made a start in 1992 after the pound was forced out of the exchange rate mechanism of the European monetary system and crashed in value. Norman Lamont initiated the Bank's "inflation report", published every three months, which gives its economic forecasts and looks at the prospects for consumer prices over the next three years. This was aimed at bolstering the government's anti-inflation credentials on domestic and international markets and became a key pointer to the direction of interest rates. But some of that credibility was eroded in the final years of the Conservative government when the succeeding chancellor, Kenneth Clarke, often overrode the Bank for being too pessimistic. Brown has gone further. Full minutes of the MPC discussions plus details of how its members voted - and why - are published within six weeks after the two-day monthly meetings. The only proviso is that MPC members are not allowed to give interviews to the media or make statements concerning monetary policy for four days preceding and following the meetings - to limit market speculation. The accountability of the MPC has few parallels elsewhere -- even in the US. The Bank's governor is required to make more reports to parliament in the shape of the treasury select committee which can also call and cross-examine individual MPC members. Finally, there is the requirement for the ultimate explanation. The target rate of inflation is the so-called "core" rate - changes in the retail price index excluding movements in mortgage interest rates (which are dependent on monetary policy). The original target for this core - known as RPIX - under the Conservatives was in a range of 1% to 4%. That has now been narrowed to 2.5% and the chancellor has decreed that if the actual figure is more than 100 basis points (bps) off target - over 3.5% or under 1.5% - the governor and the MPC have to write a public letter explaining why this has happened. This has attracted criticism that the leeway of 100 bps on the upside marks a dilution of Brown's disinflationary fervour, but the main intention points to guarding against a deflationary bias by the MPC. "We understand why the government is concerned about excessive tightening of monetary policy in a recession," said a Bank spokesman. The workings of the MPC got off to a smooth start with four increases of 25 bps in short-term rates in as many months, lifting them to 7,25% - in spite of growing anxiety among exporters as sterling's exchange rate went skywards. And the credibility enhancement in the financial markets continued. Brown's first statement on the new regime boosted gilt-edged securities immediately, driving down the yield on long-term government bonds from 7.6% to 7.2%. This week 10-year UK gilts were yielding just over 5.9%. The January and February meetings of the MPC, however, have produced sharp differences and disagreements between the hawks and doves. In January the MPC split 5 to 3 in favour of holding rates at 7.25% because of a slowdown in the UK economy and the pending impact of the Asian crises even though the Bank's forecasts pointed to inflation being higher than the target rate two years down the line. The February minutes made even more dramatic reading, revealing a more serious split. Voting on a continued rates standstill was even - with the Bank's chief economist and deputy governor-designate Mervyn King lining up against the governor in recommending a further tightening. George was forced to use his extra casting vote. The minutes of the meeting held in the first week of March will produce more fireworks. Once again the doves prevailed against the hawks. But, so far, the disagreements have not seriously fazed the markets - differences of opinion emerge regularly within the US Federal Reserve and the Bundesbank Council. "There obviously are some risks to credibility of this transparency but they are outweighed by the benefits," said David Marsh, head of European research at investment bankers Robert Fleming. Publication of the minutes is a real aid but it may be too soon to pass judgment on the MPC. "It has been going for only a short time and does not yet have the credibility of the Bundesbank, which is why UK gilt yields are higher than German bunds." At Merrill Lynch, economist Ian Stewart said: "As far as markets are concerned the new regime of independence and the MPC has been unalloyed good news. But possibly the main test of the MPC will come if a weakening of the economy coincides with a pick-up in inflation."
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