The news that the governor of the Bank of Canada, Mark Carney, would be taking the top spot at the Bank of England (BoE) came as a bit of a shock when it was announced last November. While we Brits had long adjusted to the idea of foreigners managing our national football teams, it seemed we were not quite ready for a Canadian to govern the BoE.

Yet, while MPs, city workers and the industry’s press expressed their astonishment, they could not find much else wrong with him. Credited with steering Canada safely through one of the worst financial crises since the Great Depression, Carney was widely hailed as the right man to take over from outgoing governor Mervyn King on 1 July.

Last of the King spender?

King’s ten-year reign over the BoE has been, perhaps unfairly, marked by his enthusiasm for quantitative easing (QE). While he was a little reticent to turn the tap on during the fall of Northern Rock in 2007, King’s fervour for fiscal stimulus has led the BoE to pump £375bn of freshly printed money into the economy since 2009.

In combination with annual inflation targeting, King has long voiced his belief that QE is the UK’s best, if only, chance of clawing itself out of recession.

Carney’s approach to the financial crisis during his time governing the Bank of Canada was a little different. While he did choose to implement QE in 2008, he only expanded the bank’s balance sheet by $24.4bn to $78.3bn and this has now been unwound.

Principally, Carney chose to follow the Fed and immediately slashed interest rates to 0.25% while electing not to target a strict inflation rate. As a result, Canadian inflation bounced between 3.7% and -1% during the crisis, finally settling at around 2%, while interest rates are now at 1%.

Yet, while Carney was sparing with QE in Canada, he was bolstered by Canada’s position as a commodities exporter, its contained government deficits and the lack of a property lending boom; luxuries the UK did, and does not, enjoy. For this reason, most do not expect Carney to rock the boat too much.

“The indications are that he will favour fiscal stimulus, which suggests that there won’t be a reigning back of QE,” argues Chase de Vere’s Patrick Connolly.

In the short term, Connolly reckons this will mean a continuation of current trends: rising inflation and a weaker sterling.

Avant garde or enfant terrible?

However, this does not mean Carney will come in and sit on his hands. Many, including L&G Investment Management’s economist James Carrick, expect him to announce a freeze on interest rates almost immediately.

“In Carney’s speech last November, he said that, when interest rates are at the zero bounds you can help the economy by promising to keep rates unchanged for a long time,” says Carrick.

He explains that this could be a canny move to stimulate economic activity as, if the public are sure that rates are not going anywhere for a while, they might be encouraged to borrow more, particularly on mortgages.

Ian Kernohan, economist at Royal London Asset Management, agrees that freezing interest rates could encourage consumer spending but warns that a promise to hold them down for more than two years could be dangerous.

“If all Carney does is confirm what the market already thinks, i.e. rates are going to be on hold for two years, then that’s fine. But if he indicates rates are going to stay the same for five years, sterling would weaken and you’d get a reaction in the bond market,” he says.

In the same speech mentioned by Carrick, Carney also spoke in favour of alternatives to the annual inflation targeting adopted by most central banks, including the BoE. One approach he mentioned was to use price levels or an average rate of inflation over a 12 month period instead of a fixed rate.

Using this model, if inflation were to overshoot a 2% target and reach 3% one year, the BoE could target inflation of 1% the following year. The main benefit of a target like this would be the removal of the need to raise interest rates if inflation runs above target after an economic downturn.

The great mediator

However, as bright and as promising as Carney’s ideas might be, some have hinted that he may come up against a brick wall with the Monetary Policy Committee (MPC).

Naysayers include Kernohan, who thinks the MPC might be reluctant to commit to a long term interest rate, and Stuart Cowley, head of fixed income at Old Mutual Global Investors, who says the MPC is too attached to annual targets.

“Carney’s probably used to ruling the roost and now he’s got the MPC and a collegiate environment where people vote. They’re pseudo academics – they like their numbers, it gives them comfort,” says Cowley.

These reservations hint at what many believe will be Carney’s biggest challenge and potentially his biggest contribution: bridge building. Fair or not, the image of King was often one of a ruler sitting in an ivory tower; an academic out of touch with the real world. In contrast, Kernohan believes Carney will be more of a public face, potentially inspiring more confidence in consumers.

“Carney is perhaps a little more user friendly; his record in Canada also shows he is very good at explaining monetary policy matters. He might even do an interview on This Morning, which you’d never get Mervyn King on,” he says.

According to Carrick, the most significant thing Carney could do would be to cultivate a co-operative relationship between the BoE and the treasury, the lack of which has resulted in a stalemate on asset purchases.

“The MPC wasn’t happy about buying more gilts and King wasn’t happy about buying private sector assets as any losses would have to be covered by the treasury, and it is reluctant to expand its debt for fear of being downgraded,” he explains.

However, Carrick believes that Carney could have some significant leverage.
“There’s been a stand-off” he says, “but Carney is Osborne’s man.”