Back in 2010, when U.K. Chancellor of the Exchequer George Osborne was kicking off his fiscal squeeze, he rarely tired of saying how his “credible” plans gave the Bank of England flexibility on policy.
Six years later and the story hasn’t changed much.
Cornered by his own pledge to post surpluses from 2020, Osborne must keep tightening the purse strings for the next couple of years. On a cyclically adjusted basis, the big hits are coming up, keeping the burden on the BOE and Governor Mark Carney to drive demand.
Within a 24-hour period this week, the divergence between the monetary and fiscal policy stances will be highlighted, with Osborne’s annual budget on Wednesday and the BOE’s interest-rate decision a day later. The chancellor is seen sticking to his guns to meet his self-imposed mandate, and the central bank will probably leave borrowing costs on hold as Britain’s referendum on European Union membership clouds the outlook. It cut the benchmark rate to a record low seven years ago this month and it hasn’t budged since.
“First and foremost, the Treasury will still be looking to the BOE essentially to do the heavy lifting in terms of policy,” said David Tinsley, an economist at UBS AG in London. “For now the BOE just have to kind of do nothing until the referendum is more or less out of the way.”
That dynamic between fiscal and monetary policy is embedded in Osborne’s strategy. As he told fellow lawmakers in 2010, back when Mervyn King was running the BOE:
“A robust fiscal policy gives more flexibility to monetary policy. That is the principle that I take to economic policy making.”
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Luckily for Osborne, he doesn’t have any reason to worry about the BOE’s side of the equation. Carney is in little rush to start tightening policy, saying economic conditions don’t justify it, and the possibility of an interest-rate cut has even crept into officials’ thinking.
“If we were in a position where the economy needed additional stimulus, we do have considerable room,” the governor told lawmakers on Feb. 23.
“The U.K. has been on this austerity path for a long time and a loose monetary policy is a counterpart to a tight fiscal policy,” said Brian Hilliard, chief U.K. economist at Societe Generale in London and a former BOE official. “The dynamic of monetary policy at the moment is really a `wait-and-see’ until we get `Brexit’ out of the way.”
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