Is the UK Going where Japan Didn't Dare?

Threats by Japan's Prime Minster Abe to changed the BOJ's charter faced broad criticism for threatening the independence of the central bank. Some officials reacted more strongly to this than to the bilateral exchange rate targets some officials were suggesting.

Abe has since backed away from changing the BOJ's mandate, as his candidate to head up the BOJ has promised to deliver the goods--aggressive expansion of the asset purchase scheme and possibly before the April 3-4 regularly scheduled meeting. The willingness of Iwata, a nominee for one of the deputy slots at the BOJ, to accept a change in the BOJ's mandate, is being seized upon by the opposition DPJ to oppose the appointment.


The UK appears to be adopting similar tactics. The BOE has embraced a depreciation of sterling, though stopping shy of providing bilateral targets, either against the dollar or the euro. Cameron and Osborne have agreed to replace the BOE Governor, whose term is expiring, with the head of the Bank of Canada who has promised a more activist monetary policy to offset the austerity upon which the government has staked its future.

Changing personnel may not be sufficient for Cameron and Osborne. There are moves afoot to change the BOE's charter. Recall that although the BOE is the second oldest central bank in the world after Sweden's Riksbank, it was not granted independence until Labour did so in 1998. Reports have circulated that the direction of the changes being contemplated is to give the BOE greater scope to tolerate higher inflation for longer.

In testimony last month in the UK, the next BOE Governor (July 1) Carney advocated a more flexible inflation target. In the past he has been sympathetic to targeting nominal GDP, though he has not introduced that in Canada (where Carney has led the central bank since 2008). Carney has also been sympathetic to the dual mandate of the Federal Reserve (which is really three-fold, i.e., price stability, full employment and financial stability).

The reports indicate that Carney is being consulted by the UK government on potential changes in the BOE's remit. Yet, it is not clear that the current mandate is insufficient. Currently, it is instructed to maintain price stability and support the government's policies, including its broad economic objectives in terms of growth and employment. It is a question of emphasis and interpretation.

Nevertheless, Carney, as much as Cameron and Osborne, want to be part of the "re-founding" of the BOE. Osborne was coy at the end of last year, saying he welcomed the debate on the BOE remit but had no plans to change the framework. Yet the press reports continue to suggest behind the scenes discussions are proceeding. Separately, several MPC members, including Deputy Governor Bean and Tucker and McCafferty seem to agree with our assessment that the current framework is sufficiently flexible.

Sterling has been giving the yen a run for its money this year for the weakest of the major currencies. The yen has pulled back into the lead with its recent losses which put it down 9.5% here in 2013, compared with the 8.5% decline for sterling. On the BOE's broad trade-weighted index, sterling is off about 6.8% this year. It is too early to show up in UK trade figures, and for various reasons, UK exports do not seem particularly sensitive to sterling's exchange rate. On the other hand, the depreciation of sterling appears to be one factors boosting inflation expectations.