Mark Carney’s economic geography lesson

Mark Carney’s choice of Nottingham for his first speech as governor of the Bank of England on August 28th at the University’s conference centre was, in his own words, ‘not by accident’.  The East Midlands, it emerged, is a bellwether region for the Bank based on the broad base of its regional economy, ‘with leaders in retail, manufacturing, engineering, logistics, information services, biosciences and education, Nottingham and the East Midlands are integral to the success of the UK economy’.  Moreover, Carney made it clear that he placed great store in the importance of obtaining local information from businesses and other economic actors in order to take stock of the economy.  So, not just abstract theorising for him.  At one level, this gentle flattery of the audience, in this case business leaders from the region, is the kind of thing any clued up visiting speaker says at the start of their talk – and Carney’s CV would suggested he is clued up and, on this performance, has star quality and charisma to burn – as it is a tried and tested route to get at least part of the audience onside from the start.  But beyond that, there is clearly some truth to what Carney claimed: the East Midlands might indeed be seen as an aspirational region for those trying to direct the UK economy to a more productive and competitive future.  Although not short of problems, the region has a long tradition of manufacturing and engineering and, in the form of Rolls Royce, has the kind of truly globally competitive engineering firm that employs very highly skilled ‘real’ engineers of the kind that, in the wake of the global financial crisis, a former Business Secretary wished would replace the UK economy’s surfeit of financial engineers.

Carney also used the phrase ‘real economy’ to refer to the kinds of businesses that the Bank was trying to support through its policy of forward guidance on interest rates which would be kept low until unemployment fell below 7%, and indicated that even this target would not necessarily be a trigger for increasing rates (but nor would high unemployment be a deterrent if other conditions dictated an interest rate rise, which at least gave him a get out in an emergency).  But through forward guidance Carney wants to encourage banks to lend to businesses for productive uses to enable the economy to grow in a stable and sustainable manner over the long-term.

This will no doubt be pleasing to the ‘real economy’ firms that Carney wishes to cultivate.  But the fear is that what the low interest rate regime is fuelling is not so much long term investment and improvements in productivity given the reported reluctance of banks to lend against such activities. Rather, as the economy begins to show signs of growth, what low interest rates appear to be fuelling is economic growth in the form of asset inflation in the property market.  Carney had the sense to recognise the importance of the UK housing market in his speech, and how it overshadows so much else, and assured his audience that the Bank now had mechanisms of intervention in the market beyond mere interest rates.  Perhaps, but these need to be tested in action, although the Bank may not have that long to wait to see how effective such mechanisms are.

There are already signs that the UK housing market is moving through the gears, fuelled in large part by that other bellwether UK region that is a city, London.  For example, in the year to June 2013 house prices in the UK increased by 3.1%, but in London they increased at more than twice that rate, by as much 8.1% (compared to only 0.9% in the East Midlands, for example).  All UK housing market booms start in London and trickle out from there as people decide to cash in and move out, while those that are priced out buy as close to the wave of house price rises as is affordable.  However, this nascent boom contains an additional and emergent small business sector that first came to the fore in the period of economic growth up to 2008, and that is the Buy-to-Let (BTL) landlord.  In part a product of changed expectations about welfare, entitlements and pensions, the BTL market was considered by many to have been destroyed in the wake of the crisis, not least because many of the specialist lenders that funded this market encountered considerable difficulty in the global financial crisis as the they were no longer able to access funding in wholesale markets.  However, the crisis also benefitted the BTL sector, as low interest rates cut the costs of borrowing, conservative lending practices raised the level of deposits needed by first time buyers, while job losses and the growth of precarious employment practices have made it more difficult for prospective home owners to enter the market and chose to rent.  Gross lending for new BTL mortgages increased by 19% between 2011 and 2012, while BTL investors have also benefited considerably from the introduction of the Funding for Lending Scheme (FLS) which helped double BTL mortgage applications and which, ironically, is backed by the Bank of England.

So, it’s good that by visiting Nottingham Carney recognises the significance of economic geography, and that he looked to what passes as a manufacturing region in the UK for his first major speech to symbolise the kinds of activities the Bank wishes to support.  But he also needs to keep an eye on property inflation in his own backyard from his position at the heart of the City of London.  There is one area of London property price inflation that Carney will find it difficult to control, and that is the inflow of hot money from overseas which is being used to buy up expensive properties for speculative or safe-haven reasons.  One of the reasons that foreign purchases has proceeded apace is the decline in the value of sterling in foreign exchange markets, which in turn is a product of low interest rates.  To raise the value of sterling to counteract these inflows the Bank would have to raise interest rates, which would go against forward guidance.  Tricky.  At least Carney, a Canadian, is exempt from one the main criticisms that has been aimed at ex-pats buying up expensive London mansions that are fuelling house price inflation:  he actually lives in his.

Andrew Leyshon. 28 August 2013

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