The vote by UK citizens to end the country's 43-year membership of the European Union on June 23 came as a jolt to many in the political and financial elite. It triggered severe market gyration that wiped $2 trillion off world equity markets and caused sterling to plunge to a 30-year low against the US dollar the following day. It also gave more leverage to some politicians that have called for the resignation of Mark Carney, governor of the Bank of England (BoE).
'Brexit' has already sparked bitter leadership battles in the UK's dominant Conservative and Labour political parties, forcing the resignation of Conservative prime minister David Cameron and making finance minister George Osborne's position more precarious. Amid the turmoil, the reaction from the BoE has represented a voice of calm. The UK's central bank executed a textbook example of crisis communications, putting out a short statement at around 7am British summer time on June 24 stating the BoE "is monitoring developments closely", "has undertaken extensive contingency planning", "is working closely with HM Treasury, other domestic authorities and overseas central banks" and "will take all necessary steps to meet its responsibilities for monetary and financial stability".
Carney then elaborated to a limited extent on some of the details provided in the statement at just before 9am British summer time. He stressed the strength of UK banks, saying the capital requirements of the UK's largest banks "are now 10 times higher than before the crisis" and the BoE has "stress-tested them against scenarios more severe than the country currently faces". He added that UK banks have raised more than "£130 billion [$175 billion] of capital" and have "more than £600 billion of high-quality liquid assets". Carney highlighted the BoE can provide "more than £250 billion of additional funds" through its normal liquidity facilities and can "provide substantial liquidity in foreign currency, if required".
Business as usual
Unlike the statement by the European Central Bank, released later at 11:25am Central European summer time (possibly reflecting its cumbersome approval process), the BoE's early reaction was timely, succinct and stressed that the British central bank stood ready to do what was needed. It reassured many foreign investors. And while some parties believe Carney speaks too frequently on too many issues for a central bank governor, they cannot dispute he is a gifted orator. And his calm, in-person delivery enabled the BoE to disseminate its message more widely and deeply than a simple press statement.
"The bank reacted in the correct way, which was to make a short statement – these are not the occasions for lengthy press conferences – to reassure people that in the immediate circumstance there is no threat to the financial system. And I do not think there is a threat to the financial system," Mervyn King, Carney's predecessor as governor of the BoE, tells Central Banking. "Then is it a question of business as usual. Monetary policy carries on. And that is the right thing."
The initial communication helped to prevent undue first-degree volatility in markets, albeit that bank stocks, in particular, still fell sharply. It also reflected the BoE may have learned from its experiences communicating during the height of the global financial crisis - at least so far. "The great problem with Northern Rock was that we sent two messages at the same time. One was we are taking exceptional measures to stabilise Northern Rock; the other was that there is an exceptional problem. And it turned out the second message had a much more powerful impact than the first," says John Gieve, deputy governor at the BoE from 2006 to 2009. "The message this time is 'business as usual' and 'we can handle this; emergency measures would cloud that'."
What the BoE does next is open to different interpretation. A cut in interest rates from 0.5% or more quantitative easing (QE) has been mooted as likely to be deployed at the next planned or emergency Monetary Policy Committee (MPC) meeting. But the room for either policy to have a dramatic effect on real demand is limited, and the BoE may be reluctant to cut rates further, given the slide in UK bank stocks and the importance of banks for UK money transmission. The evidence also suggests a lot of the impact is in an 'announcement effect' and additional rate cuts (which are limited in scope) and QE have a diminishing marginal impact. Given the great amount of uncertainty regarding Britain's access to the EU, knee-jerk monetary loosening may well be the wrong prescription. Indeed, the fall of sterling beyond 2013 levels may help to support a much-needed restructuring of the UK economy.
"We started QE in 2009 because we feared the economy would fall into a downward spiral and deflation. And we wanted to change the course, and it was a shock new measure to do that," says Gieve. "I do not think the bank has any shock measures of that sort available to deal with this contingency. Not only because it has used them, but also because it is different in nature."
Overstating the facts?
While Carney has done a good job so far guiding the BoE after the referendum, it was the actions of the BoE prior to June 23 that caused controversy among officials that campaigned for a 'yes' to Scottish independence and for the UK to 'leave' the EU. They claim that the analyses produced by BoE staff on the likely effects of Scottish and British independence presented significant downside risks as close to certainties and that the information appeared to support finance minister Osborne's position on both occasions. Essentially, that the BoE too was guilty of 'scaremongering', despite nobody having a clear view of how the EU and its relationship with Britain will look in five years' time.
Jacob Rees-Mogg, a Conservative member of parliament who sits on a committee that holds the BoE to account, called for Carney to be "fired" for the BoE's presentation of the risks the UK economy would face in the event it decided to leave the EU. Other 'leave' campaigners have also called for Carney to step down, despite it being well within the BoE's remit to have a view on Brexit risks to the UK economy. Indeed, it would be remiss not to have contingency plans for such an event.
It is not the first time that Carney, who became governor of the BoE in 2013, has found himself in the crossfire. The former governor of the Bank of Canada had earlier appeared to rule himself out of the job, but ultimately, Osborne – who emerged as the favourite to succeed Cameron as prime minister until the surprise referendum result – convinced Carney to move to the UK, initially for a period of five years (rather than the traditional term of eight years). Then there were his ill-fated efforts towards ‘forward guidance'. But it is Carney's apparent closeness to Osborne, who supported the 'remain' campaign, that some parties find most disturbing.
Critical to credibility
But removing Carney would be a serious mistake. This is particularly the case at such a perilous time for the UK economy, when its political leaders need to focus on renegotiating trade and services deals with the EU, particularly for financial services; redesign the UK's agricultural policies; and address issues related to Northern Ireland, rather than pick fights with competent bodies. Carney has also represented a force of change at the BoE, and is a highly competent manager who has courted support in the UK outside of the usual London metropolitan elite and is well known on the international stage. When Osborne hired Carney, he described him as "the outstanding central banker of his generation" and highlighted his role as chairman of the Financial Stability Board as an example of the esteem with which he was held by his peers around the world.
"The campaign to denigrate Mark Carney and the BoE was disgraceful," says Charles Goodhart, a UK economist and former MPC member with long experience dealine with governance issues at central banks, adding "any attempt to remove him early from his position would be exceptionally badly received by markets and commentators worldwide".
Indeed, any incoming prime minister or finance minister, whatever their personal feelings towards Carney, will need to gain credibility with the UK's creditors to ensure they keep buying its debt. It is vital to Britain's credibility that an experienced official runs the team at a BoE that has freedom of action and confidence of parliament in them. It is not just that making Carney a 'scapegoat' would send out a dangerous sign that central bank's operational independence is a subterfuge, it would also be bad politics and fail to serve the national interests of the UK at a time when parliament is in flux. As Gieve says: "In the short run, Carney is absolutely critical to the credibility of the British state."