Gaming the next rate rise at the Bank
These days the Bank of England is like the proverbial swan gliding on a lake. On the surface they haven't changed policy at all for over a year - and they've kept the base rate at 0.5 per cent for two. But make no mistake: there's plenty of activity underneath.
The system for setting Britain's monetary policy is what economists would call a "repeated game". There's one target; one policy instrument (give or take a bit of quantitative easing); and one meeting every month. All of those variables are fixed. What can change from one meeting to the next is the external environment, the views of the nine men making the decision - and, of course, the stakes.
In the past I''ve always thought that it was a bit silly to engage in a lot of kremlinology about who thinks what on the MPC: all those league tables showing how each member has voted, and where they sit on the spectrum between "arch dove" and "arch hawk". It rarely seemed that one vote here or there really mattered. But now all that's changed. Everyone is investing a lot of time in thinking about how the interest rate game might play out over the next few months, and that includes senior member of the MPC.
In recent posts I've written about the key votes to watch on the committee, and where the new member's vote might eventually go. Today I want to talk about two 'games within a game' which senior people at the Bank are pondering almost as hard as the decision itself.
Question one: does it matter, when the MPC does vote to raise interest rates for the first time in more than two years, whether the Governor votes in favour?
Question two: is it possible for the Bank to raise rates without the city assuming it's the first in a series of hikes?
Interestingly, in the intricate world which the MPC now inhabits, the answer to the two questions turn out to be related.
First things first - does it matter of Mervyn King votes for the first rate rise when it comes? Implicitly or explicitly, most of the city predictions - especially those forecasting a rise in May - seem to assume it doesn't. In general, the betting has been that Charlie Bean and Paul Tucker are most likely to change their vote, with Mervyn King and Adam Posen deemed the least likely to change their view. But for Bank insiders, the Governor's vote matters a great deal.
In more normal times, they think it's OK for the Governor to lose the odd vote - as he did in the summer of 2005, when the Bank voted to cut rates (a decision which many now consider a mistake). But these are not normal times. Imagine the MPC did vote in May for the first rate rise in over 2 years, but the Governor voted against. We wouldn't find out for two weeks. But the Governor would have to lead an exceedingly interesting Inflation Report press conference in between.
Mervyn King always insists that he speaks for the MPC in those appearances, not himself. But often you'd be forgiven for missing the distinction. Things would be even more awkward once we knew for sure that he had not voted for a change. When the Bank makes a decision this important, you want the leader of the institution to be out there defending it, without caveats and complications.
I suspect the Governor agrees with this. If so, the debate moves from when the swing voters will change their minds - to when those switchers will persuade the Governor to switch too.
If all of hat analysis is right, 'they'll all go together when they go': all of the senior Bank officials on the MPC will vote for a rate rise when it happens. (In theory you could have a change in policy with Charlie Bean, Paul Tucker, Mervyn King and Paul Fisher all on the losing side, but Adam Posen's position makes that unlikely, to say the least.)
But then think about question two: the debate over whether the first rate rise must shortly be followed by others. The received wisdom within the Bank - and outside - has been that you could not have one rate rise in isolation. But, as we heard at the ECB Press Conference last week, the ECB President does seem to think, in current conditions, that it would be possible to "send a signal" with a rate rise, without necessarily committing to many more.
With so much uncertainty hanging over the economy, and fears over the impact of the higher oil price, some at the Bank would like to have the same option open to the MPC. The last thing they want is a one point rise in the average fixed rate mortgage in response to a quarter point change from the Bank. Equally, for all the talk about 'taking it one month at a time', they don't really want to be cutting rates again, months after raising them.
I say some at the Bank might like to have the option. But the ground has not been laid for such an approach, in the city or among the broader public. Reasonably, on the basis of the Bank's past history, most observers assume that once rates go up once, they will rise fairly steadily thereafter.
If there had been any doubt about the matter, Mervyn King rather put an end to it with that line from Monty Python in the February press conference: there will be no "futile gestures", for which read "symbolic", one-off increases in rates.
So, you might think, that's another reason to expect the first rate rise to come later rather than sooner. But all this strategising does open an intriguing possibility.
If Mervyn King doesn't believe in one-off rate rises, then the city would be right to expect a series of increases after any rate rise the Governor votes for. But equally, if the Governor didn't vote for it, the city might well hesitate to assume that further rises were in the bag.
In that scenario, the MPC hawks could get their 'warning shot' against inflation without committing to a long campaign. If they could only get past the problem of the Governor spending an hour and half defending a rate rise to journalists that he didn't support.