Relief and Realism

The Chancellor’s speech on Wednesday evening was, like that of the Governor of the Bank of England, positive. Its tone reflected the feeling in the room: relief and a strong dose of realism. Relief that both the economy and banking sector were recovering but realism that much still needed to be done. Overall there was not a great deal new in the speeches. We were reminded that further progress is being made to return to normal in the banking sector. There are plans for a good bank/bad bank for RBS. The government plans to sell out of its 39 per cent stake in Lloyds in stages. The Governor reminded us, meanwhile, that the biggest banks still have significant amounts of new capital to raise.

We were left with the feeling on the economy that there was more to be done on monetary policy given that the Chancellor is sticking to his guns on fiscal policy. This fiscal stance will be reflected in his forthcoming spending review – although the Chancellor tried to imply that he will be looking at ways to help capital projects. There are few details at this stage but more spending is needed on infrastructure, both for now and the future.

The Chancellor highlighted three themes: active monetary policy; credible and sound fiscal policy; and supply side change including the banks, each of which sounded familiar. He also talked up the economy. It is healing, he said – moving from rescue to recovery, but there is still a need to treat the recovery. The public sector is still too big, paid for by a private sector that is too small. The criticism, of course, would be that demand, lending and confidence are still too low and that the recovery is modest.

I detected that Mr Osborne wants monetary policy to do even more. The Bank of England’s Monetary Policy Committee (MPC) had “largely” done enough and the report on forward guidance and intermediate targets would be released in August. I expect this will support what The Governor, Mark Carney probably wants, to allow the MPC effectively to do what the US Federal Reserve is currently doing and outline the conditions under which monetary policy would return to normal. Yet whereas the Fed is signalling its gradual exit strategy, the Chancellor seems to want the MPC to do even more.

The Chancellor, conscious of recent criticism perhaps, defended the Funding for Lending scheme (FLS). It had, he said, reduced funding costs for banks (I agree and this is good), but it needed to do more for SMEs. He defended what the FLS and Help to Buy combined were doing to housing by saying mortgage finance needs to be fixed. He felt that the mortgage market was not working as first time buyers needed four fifths of their annual income for a deposit. However, the real issue is on the supply side. Current house building is far too little. The last thing we need is a temporary housing boom that will clearly go bust when rates eventually start to rise.

The Governor talked of the economy, on which he was cautiously optimistic. But he doesn’t want monetary policy to be tightened anytime soon – even though interest rates, he said, were unsustainably low. He stated that unemployment was more of a risk than inflation, and that there was still much spare capacity. I would agree with this, yet, as I have argued since January, the economy may grow at a stronger pace than expected this year. He also spoke about the financial sector.

On banks, both speeches reflected the general mood in the room – let’s not knock the City and be positive towards banks but let’s also recognise the need to change. The Governor talked about the ethics and culture of banking and the need for greater responsibility – and said that governance needs to change. He also felt that while leverage ratios were down they were still too high – and that the banking sector was still an obstacle to growth.

While the speeches supported the latest measures from the Commission on Banking, the general feeling from the bankers was wariness about how some of the proposals might be implemented. Yet the underlying message of the evening was that the City succeeds because it adapts and thinks globally – and thus there is a need to ensure the right regulatory regime which will boost London’s future competitiveness.

*Dr Gerard Lyons is chief economic advisor to Boris Johnson, the Mayor of London.

Dr Gerard Lyons

Dr Gerard Lyons is an international economist and Chief Economic Strategist at Netwealth Investments, having previously served as Chief Economic Adviser to Boris Johnson while he was Mayor of London. He was Co-Founder of Economists for Brexit and is co-author with Liam Halligan of Clean Brexit (Biteback, 2017). For Politeia he was co-author of Banking on Recovery: Towards an accountable, stable financial sector (2016).

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