The importance of being Mervyn

Oh what fun at the Bank of England. With MPs away, Governor Mervyn King has managed to grab the headlines for the third consecutive week. Who said banking is boring?

Not at the Bank of England, where it emerges that King was outvoted by other members of his monetary policy committee on the thorny issue of quantitative easing. Here is a lesson in transparency for MPs so keen to hide information from the public. We have a much better idea of what is going on if the facts are presented openly.

No doubt it would have suited King better to hide the fact that he was outvoted and we should think more of him for his candour in arguing his corner despite knowing that the minutes of the meeting would be published. It is rare indeed that he is in the minority on the nine-person committee. It has happened only twice before, in votes on interest rates, and if memory serves me correctly he lost by only one vote on both those occasions.

This time he was outvoted by six to three and the fact that the margin of defeat was wider is highly significant, as it puts into context King’s views on the economy.

The vote was on whether to increase the amount of money available for the quantitative easing programme and, if so, by how much. King and two other MPC members voted for an extra £50 billion; six members voted for just £25 billion. The cash will be used to buy government and company bonds in the hopes of freeing up the cash shortage in the economy.

It is very important to be clear about these figures, as many commentators have talked about the quantitative easing programme being increased by £50 billion. Not so. The bank still had £25 billion to spare out of the original £150 billion set aside. An extra £25 billion has been added, leaving the Bank with £50 billion to play with.

King has this month made clear his views that the recession is deeper and will last longer than is widely believed. Because he is independent, his opinion carries weight. He does not have an axe to grind, as politicians on both sides of the House of Commons have, and he has access to all the economic information available.

The vote of the MPC has been presented as a vindication of his views. Although he lost the battle to increase the quantitative easing programme to £200 billion, the argument put forward in the media is that all committee members agreed to a substantial increase in the programme and it is only a matter of time before he persuades enough members to go all the way.

The reality is rather different. King wanted an extra £50 billion and the committee agreed to only half that amount. Seen this way, £25 billion smacks of a face-saving compromise. It sounds very much as if most members of the committee were reluctant to increase the amount of money at all and it will take some heavy arm twisting to make them relent at future meetings.

Now, £25 billion may be a lot of money to you and I but it is not a vast amount in the great scheme of things. Since the Bank had not yet got through all the £150 billion that was originally agreed, it was not such a big deal to settle for £25 billion and play for time. That way the Governor gets an increase while his opponents put a break on the programme.

Now we can see why it is important to get the amount of the increase right. Far from this vote being a sign that the recession is worse than expected and that more money will be pumped into the economy, the MPC vote suggests that most members do not agree with the doomsday scenario.

We now have the interesting situation that King is arguing for a hefty increase in quantitative easing because the recession is so bad, which means that quantitative easing has not worked so far. It is hardly surprising if other committee members are coming round to the view that the whole idea is doing more harm than good.

The implications for the stock market are positive, firstly because the recession is probably not as bad as King fears and secondly because interest rates will remain at 0.5% for some time as the main weapon in the fight to get the economy going. Low interest rates make shares more attractive in comparison to savings accounts.

It is true that shares retreated earlier this week but that was to be expected after the surge through July and early August. What is striking is that the correction was so weak. I would have expected a larger drop in the FTSE 100 index at this stage. We could still get a more serious downturn in September when trading cranks up after the holidays but for now at least the market has upward momentum.

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