6 Oct 2011

An audience with Sir Mervyn: two queasy tightropes for the Bank

The phone call came in at 1230. An invitation to see Sir Mervyn that would have been unthinkable three or four months ago. He has only done a round of interviews like this once before, in March 2009, when QE was first launched. We only seem to get these audiences when the Governor has decided to create magic money to try to cure an ailing British economy.

And I identify two tightropes he is walking.
First thing. UK economic prospects have deteriorated seriously. This is down to Europe says the Governor.

“It’s undoubtedly the biggest financial crisis the world economy has ever known,” he told me.

“The whole world is at stake,” he said, if debtor and creditor nations in the world economy don’t sort these long term issues and when I told him I’d thought the eurozone was going to collapse, he said: “Collapse is not a well-defined phrase” which perhaps suggests he could predict something drastic happening to the single currency.

He clarified that history showed it was very difficult to make predictions in a financial crisis. “I do not know when it will come to an end,” said Sir Mervyn.

So far so bad.

But things are only bad enough to warrant a monetary policy response. Not bad enough to warrant a two-engined stimulus from fiscal policy too. It was both Treasury and Bank of England working in tandem that boosted the UK economy in 2009/10. Sir Mervyn believes that monetary alone will do the trick this time.

“Monetary policy is the right instrument because we can change it quickly. The Government cant change its spending programme quickly,” he told me. Music to George Osborne’s ears. The Governor was highly supportive of Coalition policy, at a moment when he could have chosen to be cautious.

The other tightrope was inflation. It has exceeded target for 60 of the past 72 months, and it is imminently heading for 5 per cent. A recent BoE report said that QE1 had added 1.5 per cent to inflation. I said that there were doubts about the commitment of the bank to the inflation target.

“There’s absolutely no question of our commitment [ to the inflation target…] We will not take risks with inflation,” he said pointing out that inflation could be below target by the end of next year. Though September inflation might hit 5 per cent, he said that was “in the past” and “it probably will have peaked”.

More from this important interview tomorrow.

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