Bank of England's Newest Policymaker Ian McCafferty Speaks Out for First Time

The newest Bank of England policymaker to take a seat on the rate-setting Monetary Policy Committee (MPC) has given his first analysis on the state of the UK economy and the central bank's schemes to get it moving again, claiming he is "neither a hawk or dove" when it comes to making key decisions.

Ian McCafferty, who left his role as chief economic adviser at industry lobbyist the Confederation of British Industry (CBI) to take up the Bank post, has given a series of answers to a questionnaire in advance of his debut appearance in front of parliament's Treasury Select Committee (TSC).

"I am neither a hawk or dove. I will be looking at the evidence in each meeting, on the basis of the best data that we have, to make a decision on the basis of current policy," he said.

Outlook for UK economy

McCafferty outlined his approach to policymaking, his views on the state and outlook of the recession-hit British economy - where he stuck to the Bank's view that the eurozone crisis is the biggest hindrance.

"The continued uncertainty about the outlook for the sovereign debt and banking crisis in the eurozone continues to weigh on business confidence and, with growth rates across the eurozone slowing, the risk of a deeper eurozone recession hitting export demand from the UK (to what is still our largest single export market) has increased," he wrote.

"Serious financial market disorder or a banking crisis in the eurozone would have significant negative effects on the UK economy."

Blame has also been laid at the door of the wider global economy in recent forecasts and analysis by the Bank's policymakers, something McCafferty, who has worked for oil giant BP and Natwest in the past, also echoed.

"Recently, there have also been signs of a loss of economic momentum more widely, with both the US and Chinese economies slowing since the early part of the year," he said.

"If this were to persist into 2013, the outlook for the UK would be consequently weaker."

He also said that the biggest issue for the domestic economy was seriously dampened consumer demand, which has been hurt by a recent period of high inflation and stagnant wage growth that eroded disposable income.

Falling inflation should ease this squeeze on household finances though McCafferty cautioned that rising raw materials prices, such as for crude oil and agricultural products, may cause inflation to fall more slowly than anticipated.

Inflation rose unexpectedly in July to 2.6 percent.

"These downside risks are to a certain extent already built into existing forecasts of the outlook for the UK," McCafferty said.

"If they do not materialise, or are quickly resolved, growth in the UK economy may be higher than current projections."

Unemployment has fallen in recent months, despite a sharpening recession and continued uncertainty over the future for the economy, something that has many economists scratching their heads.

"The market is perhaps functioning in a way differently than one or two cycles ago and that leaves us with a conclusion that probably productivity, rather than the level of employment, is becoming more cyclical in terms of how firms deal with shortfalls in demand in the short term," McCafferty said.

Bank's QE programme

Since January 2009 the Bank of England has pursued a quantitative easing programme under its asset purchase facility (APF), which sees it buy up gilts from the market to improve liquidity and free up cash on business balance sheets in the hope they will then invest this in jobs and growth.

Its current target value of £375bn has been raised three times from the original £200bn figure.

Many economists think the figure is likely to be increased further, though some question the efficacy of the APF as the economy has double-dipped back into recession for the second time in four years.

"It is difficult to be precise about the effects of quantitative easing, both because we do not have a counterfactual of how the economy would have performed without it, and because there is little evidence about likely time lags between the implementation of the policy and the full impact on the economy - as far as the more recent programme of QE is concerned, we are still in the early stages," McCafferty wrote.

"However, it would be difficult to argue that it has had no impact. Following the announcement of the first round of QE, asset prices reversed their previous downward trend, and estimates of the impact on gilt yields suggest that they were up to 100bp lower as a result of QE than would have been the case.

"The impact on both market sentiment and liquidity of the first round of QE, undertaken at a time when credit markets were effectively frozen, seems also to have been positive."

Credit easing schemes

In a bid to free up affordable credit for smaller businesses in the UK, who are struggling to find finance which would allow them to survive or expand, the Bank launched two schemes.

British banks are wary that a financial catastrophe from the eurozone area could cause them serious losses, and so the uncertainty surrounding their future is causing them to keep the purse clamped shut as they are unwilling to take on additional lending risk at the moment.

The first scheme is the Extended Collateral Term Repo (ECTR) and sees banks able to use poor assets in secured borrowing from the Bank of England, who will also offer a discount rate on the loans.

In the inter-bank market only high-quality assets are able to be used as collateral. Now banks will be able to offer up low-quality assets such as consumer credit card debt in order to secure transactions.

A second initiative, called the Funding for Lending Scheme (FLS), allows banks to borrow cash from the central bank at a discounted rate in direct correlation to the amount they lend to the so-called "real economy" of business and consumers.

The more they lend out, the more cheap cash they can borrow.

McCafferty said he thinks the latest efforts are "likely to be of benefit" though this will only be seen over the medium term.

"Together these should help expand lending flows to the broader economy, though the impact is likely to be more visible over the medium term, as it is likely to take time for the increase in lending to take effect," he said.

"If inter-bank liquidity were to dry up as it did in the months following the collapse of Lehmans, this would pose risks both to the stability of the UK banking system and further depress levels of lending.

"The activation of the ECTR, which would permit repo operations against a wider range of collateral, is a useful precautionary measure to help support lending conditions in the event of liquidity stresses within the banking system re-emerging."

McCafferty's comments suggest he is unlikely to disrupt the current train of thought and policy at the Bank of England.