Why is the Bank of England Avoiding the M-word?

Let's begin with a question. What key economic word was not mentioned in the Bank of England's recent 44-page Inflation Report?

Don't worry, it is not a trick question. The same word was not in the previous Report in May either.

The answer is not "Brexit". The missing word was "money”. Pause. Digest. Think. Yes, money. I do not describe myself as a monetarist, but monetary developments are like an indicator on a dashboard, essential to keep an eye on. One would have thought a central bank, above all, would appreciate this.

Since the 2008 banking crisis, monetary policy has been the economy's shock absorber, here and elsewhere. Record low rates and quantitative easing have worked, preventing recession and deflation. 

So much so that the US Federal Reserve is well underway in tightening policy. And in just over a week's time central bankers from around the world flock to Jackson Hole in Wyoming for their annual policy event. The theme is "Fostering a dynamic global economy". The subtext is, how to tighten policy without scuppering recovery? 

This year, attention will focus on European Central Bank chief Mario Draghi's speech. The ECB has joined the Bank of Japan in being out in front, foot down on the gas. The welcome news is both Japan and the euro economies are finally recovering. 

While good, this cyclical recovery in the euro area should not divert attention from underlying fundamental flaws that have exposed deep regional divides in the EU. This is seen most between Germany and the Northern European economies versus Italy and Greece. Spain and Ireland are recovering, although in Ireland's case only after one in four of its young people have emigrated while for Spain, where two out of five young people are unemployed, a rebound is long overdue.

So Jackson Hole should mark another important step in central bankers across the world accepting the case for policy normalisation. 

Global monetary conditions are consistent with other indicators pointing to solid growth and low inflation. This is allowing financial markets to perform well and should see government budget deficits improve more than politicians realise.

What does this mean for the Bank of England?

Although the recent Inflation Report was downbeat, at the press conference the Governor acknowledged some economic positives. The UK is at full employment. Inflation looks set to peak this autumn and should fall next year, boosting real incomes during 2018. Meanwhile, global growth should boost UK exports, especially if exporters increase volumes not prices. And while growth may be slower, it will be more balanced, driven by exports and investment. 

Of course, challenges exist. Wage and productivity growth is slow. People spend too much on renting properties or borrow too much to buy them instead. We need to build more houses and cut stamp duty to boost turnover in the secondary market.

The economy’s potential growth rate is falling. The Bank thinks it is under 1.75 per cent. That seems low. Brexit is not the reason. Their view of trend growth has fallen every year since the banking crisis, from 2.4 per cent almost a decade ago. This is a deep-rooted problem, clearly not solved while we have been in the EU. 

Low rates have unintended consequences. Financial markets are not pricing properly for risk. Banks regard government bonds and property as the only safe-assets. Yet, while savers are penalised, stock markets and property prices are riding high. Low rates have lowered the price of debt, contributing to increased leverage, and a rise in household borrowing. And then there is the biggest challenge. As low rates have become the drug, it is not clear how financial markets or the economy will cope if they are withdrawn. 

Given such challenges, this points to the need for clarity and no policy surprises from central banks.

The trouble is, we no longer have a sense of direction of travel at the Bank. In the City the view is the Bank talks like a hawk but acts like a dove. Many wonder is this an indirect way to influence the currency markets? Currently, there are far too many speeches from senior Bank of England officials, creating unnecessary noise and confusion. One moment upbeat, the next down. Hardly likely to inspire confidence among business. 

The only consistent message from the Bank is a negative view of Brexit. And yet that is the one thing they, like the Treasury, seem to get completely wrong. Order books are at a three-decade high. Foreign direct investment into the UK has soared in the last year, and long-term leases are being signed across the City too. This has the hallmarks of a Brexit dividend! 

Despite their huge media profile, the Bank is not addressing some big issues. Economist Peter Warbuton for instance has highlighted the surge in bank lending in recent years to non-bank financial institutions. Also, should banks be lending more to small and medium sized firms - and across the regions too?  

I have been supportive of Bank of England policy - although I would not have voted to buy corporate bonds last autumn. We should be realistic about near-term challenges, but there needs to be a greater sense of clarity and confidence about the future. And when the November Inflation Report is released, "show me the money". 

This column by Gerard Lyons appeared in the Sunday Telegraph on 13th August, 2017