Carney fires the first blast from “macro pru”
November 28, 2013 5:15 pm
by Gavyn Davies
Mark Carney’s announcements today about the UK housing market represent the first blast from a major country of a new policy weapon that is increasingly available to the global central banks, a weapon known as macro prudential regulation. Because this weapon is seen as an alternative to raising short rates, not as a prelude to raising them, the Carney intervention should logically under-pin the lower-for-longer path for short rates discussed in his evidence to the Treasury Select Committee earlier this week. Mr Carney has turned more hawkish today, but not more hawkish about interest rates or sterling.
The Carney announcement will represent an important restraint on the UK housing market, which was showing distinct signs of getting too ebullient in the south east of the country. By acting early, and using methods that are distinct from the short term interest rate, this action may well make the economic recovery in the UK more durable than otherwise, though it may slow down some parts of the consumer sector in the immediate future.
The specific action taken today impacts the Funding for Lending Scheme (FLS), which will be adjusted in order to redirect lending from the mortgage sector towards small businesses (SMEs). This is a step in the right direction, though there is plenty of anecdotal evidence that the availability of credit for SMEs has normalised in recent months. Since it is unclear whether the FLS has had much direct impact on the housing market (as distinct from Treasury’s Help to Buy Scheme, which has completely changed the psychology in the market), I would not exaggerate the importance of this particular change.
However, Mr Carney has simultaneously issued a strong warning that he believes that there are rising risks of over-exuberance developing in the housing market, and has spelled out the possible actions he may take in the future to control the market.
There have been some doubts about whether the Bank now has the power to direct the Treasury to make changes to the Help to Buy Scheme itself. In a letter last week to the Treasury Select Committee, the Governor explained that he has no formal powers, but that he can issue advice to the Treasury about the longevity of the scheme, and on important details like the £600,000 eligibility cap on house prices. He also said that he can issue such advice “at any time”. Since it is highly unlikely that the Treasury would reject the Governor’s public advice on such matters, it is clear that the Bank has acquired a lot of muscle in this arena.
Furthermore, the Bank retains the ability to vary the capital requirements on mortgage lenders if they are engaging in loans that are considered too risky. That also gives the Bank the ability to prevent a weakening in the underwriting standards on mortgage lending as the housing cycle proceeds.
So while the change in the FLS taken on its own is only a minor step, the fact that the Governor has started to talk about the risks to financial stability “if there are further substantial and rapid increases in house prices and a further build-up of household indebtedness” is significant. It would be surprising if UK households entirely ignored this warning.
Does this mean that UK macro-economic policy is becoming confused about what it is trying to do? Up to a point, the answer is “yes”. The Treasury’s Help to Buy Scheme may have been designed to assist first time buyers, rather than to re-ignite house prices, but it has clearly had the latter effect. It is hard to see how a renewed house price boom, from already elevated levels, can help the stability of the economy in the long term, so the willingness of the Bank to slow down this process seems welcome.
Earlier in the year, the Bank may not have been sufficiently confident about the sustainability of the economic recovery to have taken this type of action. Now it is.
Looking outside the borders of the UK, the combination of quantitative easing and lower-for-longer short rates has of course greatly increased asset prices as the forward interest rate used to discount future profits and rents has fallen in equities, credit and housing markets. This has brought forward returns on these assets from the future into the present, even if it has not caused “bubbles” under the strict meaning of the term.
None of the major central banks wants to dampen asset prices through raising short rates, since the expectation of a prolonged further period of near-zero short rates is deemed essential to induce a rise in capital spending by corporations, which is the key missing ingredient to the economic recovery so far. So we are seeing further evidence of the “separation principle”, under which the central banks will try to prevent asset price bubbles, while still encouraging an expansion in other forms of economic activity.
Will this work? In the decades before 2008, regulatory actions had generally been abandoned in favour of interest rate action in the central banks’ armoury. In the words of Fed Governor Jeremy Stein, the short term interest rate is the only weapon that can be guaranteed to “get in all the cracks” of the economy. Any form of regulatory control invites the private sector to find ways around it, and can become increasingly hard to remove. But these distortionary effects on the financial market can take a long time to become visible, and they are not considered very relevant at the moment.
Mr Carney’s decisions today may therefore be the shape of things to come from many other central banks in the developed world.
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