Till Time's Last Sand

by David Kynaston

  Radice: What kind of procedure?

  George: Where every time there is a problem, there is a great investigation, you want blood –

  Abbott: You are accountable to Parliament.

  George: I have just said I do not object to this procedure. All I am trying to say is do understand –

  Sedgemore: You said that sarcastically.

  George: I did not say that sarcastically. I am not a sarcastic chap.

  Sedgemore: You did not mean it.

  George: I did mean it. I accept this kind of procedure and I accept that it has to apply a 100 per cent standard, but I tell you this, if you want better regulation you have got to take account of the fact that this kind of witch hunt every time something goes wrong is going to make it very difficult to get people to do it.

  The following week, back in the calm of EC2, George observed to Quinn that ‘the real substance of the criticism of the Bank related to its understanding of – and supervision of – securities business’; while in early September, meeting with Quinn and Foot, he noted that ‘it was clearly important that the Bank should have expertise in new products as, for example, in the traded markets/models area’ and said that he was ‘very conscious’ of ‘the criticism that the Bank knew all about banking but not securities markets’. At the same meeting, Foot pointed out that ‘typically experts had backgrounds in accountancy, maths or economics’ and that ‘the difficulty was in recruiting people with direct Treasury or capital markets experience who were generally too expensive’. Undoubtedly, the Bank was under some pressure. ‘Trying times on Threadneedle Street’ was the title of a major piece in the September issue of Institutional Investor, concluding unenthusiastically that, in the absence of a radical redefinition of the Bank’s role, ‘the Old Lady will likely continue to muddle through in her traditional manner’.48

  Over the next year and a half, the Bank tried hard to raise its supervisory game and quieten the critics. In July 1996, following input from Arthur Andersen, it announced risk-assessment models that would ‘bring the line supervisors into direct contact, on site, with a wider range of management’; that it would ‘promulgate a clear summary of standards it expects to apply’; and that from September its Supervision and Surveillance Divisions would be restructured, enabling the Bank to, among other things, ‘improve and harmonise the assessment of risks to which banks are subject’, ‘recruit more specialists and experienced bankers from the market’, and ‘develop further co-operation with other regulators at home and abroad’. Later that autumn, Davies launched the Bank’s own publication, Financial Stability Review, seeking to stake the intellectual high ground (not least in an article by Christopher Huhne on rating sovereign risk); in mid-November, the governor again gave evidence to the Treasury Committee, continuing to insist that, though the Bank was steadily improving in its supervisory capacity, expectations of supervision needed to be realistic; early in December, the deputy governor gave a lecture at the Chartered Institute of Management Accountants, setting out in some detail the Bank’s approach (‘as far as possible, a light touch … an approach based on the principle that market participants can do what they want unless we say that they can’t, rather than that they can only do what we say they can’); and a fortnight before Christmas, the Treasury Committee published its own rather belated report on the Barings disaster and its implications. Criticism of the Bank was plentiful. As ‘a cheerleader for the City’, it remained exposed to the danger of ‘regulatory capture’; it was not yet ‘apparent that the banking sector has earned the soft touch provided by the Bank’; and the post-BCCI supervisory culture of relying less on trust ‘did not apply in the case of Barings’. ‘The Bank needs to demonstrate,’ concluded the report, ‘that it is able to separate its supervisory activities from its other functions and avoid any possible weakening of its regulatory effectiveness due to its proximity to the day to day banking market. Otherwise it may be that in order to bring about the necessary cultural change banking supervision will have to be taken away from the Bank of England.’49

  Earlier in 1996, in the last of the LSE lectures, George had spoken about the Bank’s ‘three core purposes’. The first, obviously, was ‘maintaining the integrity and value of the currency’, aka monetary stability; the second, indeed, was ‘maintaining the stability of the financial system, both domestic and international’; while the third was ‘seeking to ensure the effectiveness of the United Kingdom’s financial services’, which in practice largely meant seeking to protect and enhance the competitiveness of London as an international financial centre. On this last aspect, George’s strictly unsentimental approach – almost unreservedly accepting the forces of free-market globalisation – had been exemplified the previous year by the Bank’s policy towards the merchant banks, once so umbilically attached to the Bank itself. Not only did he let Barings go, but soon afterwards he did not seek to intervene as Warburgs, Smith New Court and Kleinwort Benson all passed into foreign ownership. The crux was Warburgs, so long the leader – the national champion – in the field. ‘The most important factor was that any deal was commercially realistic,’ he told Warburgs’ David Scholey in April 1995 after Scholey had asked if the Bank had any preference between the two front-runners – NatWest and Swiss Bank Corporation – to take over his beleaguered firm. ‘If both parties believed it to be so he could see the argument in favour of establishing two strong British houses, other things being equal. But he would not wish a deal to be undertaken for emotional reasons. Sir David asked whether the Bank’s experience of Morgan Grenfell [the merchant bank acquired by Deutsche Bank in 1989] suggested that life was more complicated where there was an overseas parent. The Governor said that this was not his impression …’

  Elsewhere, a similar lack of sentiment informed the Bank’s money market reforms, aimed at enabling the Bank to trade debt through a much broader spectrum of institutions, while at the same time enhancing the liquidity and depth of the gilt market. ‘The [discount] houses were fairly depressed because our proposals went further than they had expected in cutting off their access to late lending after the transition period, and by the open access rather than club approach to OMO [open-market operations] counterparties,’ reported Plenderleith to the governor in December 1996. ‘They saw the prospect of diminished privileges as threatening their credit standing …’ George was unmoved, and in March 1997 the Bank duly ended the privileged position of the discount houses by switching its daily open-market operations to a gilt repos system open to all-comers; Union (the former Union Discount) announced that it was winding down its positions prior to putting itself up for sale; and the following year the last discount house returned its licence to the Bank.

  What about the impending euro? As early as September 1996, more than two years ahead of the eventual launch, George insisted that whether Britain was in or out of a single currency, the City would thrive. ‘The euro is just a bigger Deutschmark,’ he declared. ‘We have seemed to do perfectly satisfactorily handling the mark, just as we have the dollar and yen. I am sure that the City will cope.’ Few observers believed that George himself was an enthusiast for British participation in economic and monetary union – the prospect of the Bank of England becoming a branch office of the European Central Bank was hardly likely to enchant a Threadneedle Street man. But it was becoming clear that the new currency was going to happen, and the Bank devoted considerable time and resources to ensuring that, irrespective of the question of British membership, the City was fully prepared. ‘We aim to identify any initiatives where we at the central bank need to take the lead to provide system-wise facilities, and these we have in hand,’ Plenderleith in November 1996 assured participants at the City of London Central Banking Conference. ‘Interlinking the individual RTGS [real-time gross settlement] payment systems in TARGET [the euro payment system] is one. Discussion with market participants of the appropriate legal framework for the euro, and of bond market trading conventions, are two other areas. This exercise to prepare wh
olesale market activity for the euro is now proceeding on a broad front in the UK and we are pleased with the concrete progress being made. We will continue to be active as a catalyst …’50

  By the mid-1990s it was the Bank’s first core purpose that had become most core of all. ‘Do inflation targets work?’ was the title of King’s September 1995 address to the Centre for Economic Policy Research, and his conclusion was that they had led over the past three years to ‘a more systematic and focused discussion of the monthly decisions on monetary policy, both inside and outside government’; while in March 1997, profiling King, the economic journalist David Smith declared ‘without hesitation’ that ‘Britain’s inflation performance in the 1990s has been better than for 25 years’ and argued that inflation targeting had played its part – not only by forming ‘the basis for all the monetary policy discussions between Chancellor and Governor’, but also by helping to create ‘a climate in which low inflation is seen as the norm’. It was not, at the Bank end of the process, necessarily painless. ‘You discussed at some length the preparation of the Bank’s forecast and the press briefing for the Inflation Report,’ began a note to King from the governor’s office in November 1994 after his recent meeting with George:

  The Governor said that he had not realised that he and you feel differently about the immediate outlook. He felt that the Inflation Report had been too sanguine. You thought that there were significant and asymmetric risks on the upside but nevertheless that the central forecast was plausible. There was no point doing careful analysis if it was ignored and the published forecast drawn on the basis of a hunch. The Governor said that the forecasters could not expect to dictate the Bank’s policy stance but, of course, their analysis was a very important input into the process. It was agreed that the Governor should be involved in the preparation of the forecast at an earlier stage …

  King himself had a clear vision of how the formation of monetary advice-cum-policy should operate, and some two years later, in a presentation to senior colleagues, reiterated his ‘determination for the Bank to retain the intellectual leadership in the debate on monetary policy’. Turning to ongoing activity, he then gave some specifics. ‘Work in the group of small models had largely been completed, and major progress had been made in the work on the accountability and credibility framework of monetary policy’; as for forecasting, he asserted that one of the Bank’s ‘major achievements’ was its ‘relative openness in describing the uncertainty and balance of risks surrounding our forecast’.

  Soon afterwards, in his November 1996 lecture at Loughborough University, George carefully set out all the various elements involved in the post-ERM monetary policy framework. On the Inflation Report side, these included transparency (‘the Bank’s professional reputation is on the line as never before’), its forecast of inflation two years ahead (‘we now illustrate the extent of our uncertainty by displaying the forecast as a probability distribution, a sort of open fan on its side – with the uncertainty typically increasing though not necessarily symmetrically’), and intense discussions ahead of the forecast (including about ‘the behavioural assumptions in the light of past relationships and the news in the current data’). On the regular chancellor/governor meetings side, he emphasised that for all their relative brevity, they had been preceded by a sustained, multi-element process – including in the Bank an internal ‘Monthly Economic and Financial Report’; followed by a Monetary Review Committee chaired by the deputy governor and attended by some fifty officials; followed by a meeting of the Monetary Policy Committee (MPC, not to be confused with the post-independence MPC), recently established to determine the Bank’s line each month, chaired by the governor and attended by about a dozen; followed by the Bank’s assessment being sent to Burns at the Treasury; followed by a Bank team of seven or eight led by the deputy governor meeting their Treasury counterparts; followed by preparation of the draft speaking note for the governor; followed by a further meeting of the MPC to agree the text of the speaking note; and then at last the more or less monthly chancellor/governor summit, with the latter accompanied by his deputy and the two directors (King and Plenderleith) of the Monetary Stability Wing. ‘This meeting is sometimes represented as a rather casual affair lasting no more than an hour at which we might almost toss a coin,’ observed George. ‘The reality is not quite like that.’51

  In truth, the ‘Ken and Eddie show’ – Clarke’s ironic coinage, in reference to their regular press conferences – was a source of some vexation to George, and not only because its very existence confirmed that the Bank had not yet achieved independence. Ostensibly the two men got on well, but ultimately the governor, as a deeply engaged technician, was frustrated by the politician’s almost entire lack of comparable depth. ‘I don’t know why I bother,’ he even remarked on one occasion as he was driven back to the Bank. In general the pair were seldom radically opposed in terms of what they wanted – ‘Eddie and I never got more than twenty-five basis points [0.25 per cent] apart,’ Clarke would recall – but their instincts and approach throughout remained essentially different.

  The key episode, graphically revealing how far the Bank was from genuine autonomy, came in May 1995, against the background of appalling election results (both local and European) for the Major government. On the late afternoon of Thursday the 4th, polling day itself and the eve of the monthly meeting, George was on the phone with the permanent secretary:

  Sir Terry told the Governor that the Chancellor, having slept on it, was inclined not to increase interest rates the following day. He was aware of the importance of the decision and felt that he could not win either way, but in his heart of hearts he was not persuaded of the case for an increase [from 6.75 per cent to 7.25 per cent] now … This was not the Chancellor’s final decision, but it was ‘pretty final’ …

  The Governor asked whether the Chancellor understood the full extent of the risk he would be taking. There was a real chance that even before he appeared at the press conference [to explain the no-change], the exchange rate would have fallen very sharply. There was no doubt that an increase in rates had already been factored in to the current exchange rate. The Governor said of course he could not know for certain what would happen, but he had a duty to say that there was a significant possibility (which he put at least at a 1 in 3 chance). The Governor stressed that it was by no means a black and white decision, but the point was that the Chancellor would be overriding almost everyone’s advice and the risks were asymmetric. This could be deeply damaging to the policy-making framework.

  George added that ‘taking such risks with inflation is precisely what had undermined UK economic policy-making so often in the past’; and he finished by asking Burns to tell Clarke that, in relation specifically to sterling, ‘he [George] was extremely nervous about the position’. Next day, ‘Ken and Eddie’ duly met – and the chancellor decisively rejected the case for an interest rate rise, a stance widely interpreted (especially after the publication of the minutes six weeks later) as an assertion of his authority over policy. George in public would utter some emollient words, for instance declaring in a speech in Manchester that their ‘disagreement about the inflationary outlook’ had been ‘well within the reasonable range of uncertainty’; but the reading by Anatole Kaletsky, that he had ‘clearly expected Clarke to blink’, and had subsequently been disconcerted by the lack of reaction from the markets to the chancellor’s metaphorical shrug of the shoulders, was probably not far off the mark.

  Perhaps inevitably, tensions also featured during the run-up to the May 1997 general election, as at four consecutive monthly monetary meetings Clarke, fortified by sterling’s strength, rejected George’s advice for a 0.25 per cent rise and bluntly insisted that he saw no sign of inflation. He even, in January 1997, publicly criticised the Bank, telling the Financial Times that it ‘took too much notice of predictions in the financial futures markets that interest rates would have to rise’ and claiming that ‘it was usually wrong to assume that the m
arkets had a feel for the real economy which the Treasury lacked’. By its last curtain call, it was a show that probably neither performer was much enjoying.52

  The Bank’s tercentenary virtually coincided with the creation of New Labour. Crucial to that project’s architects were a desire for economic credibility; a fear of the destructive power of the markets, as evidenced by Black Wednesday; and a historical awareness (especially on Gordon Brown’s part) that previous Labour governments had suffered from their troubled relationships with the City. With no possibility of Major changing his stance towards the Bank’s position, and presumably struck by the opposition’s handsome lead in the opinion polls, George and his colleagues spotted an opportunity. A starter of cream of chicken and sweetcorn soup, a main course of fillet of sole with scampi and lobster claws in white wine sauce, a dessert of lemon meringue pie – such was the fairly conservative menu, chosen by the governor, for a getting-to-know-you dinner at New Change in February 1995, to be attended by Tony Blair, John Prescott, Robin Cook, Alistair Darling and Andrew Smith as well as the shadow chancellor Brown. ‘EG said to TB the City was not worried about a Labour government provided it was TB’s government not Old Labour,’ noted Alastair Campbell next day on the basis of Blair’s account. ‘JP then proceeded to play up to his Old Labour label, e.g. when house prices were being discussed, why do you people talk about housing in terms of house prices not homelessness. TB said Robin C was not far behind. He laughed and said “I’m sure I heard Eddie say get me the BA emergency desk as we left.”’