Bank of England boss highlights 'well-worn' link between political upheaval and business investment

Andrew Bailey declined to venture a direct opinion on the issue of Scottish independence, which has surged back to the top of the political agenda in light of Brexit and coronavirus, when asked whether the raging constitutional debate would weigh on business investment in Scotland.

But, speaking at a Scottish Chambers of Commerce webinar yesterday, he acknowledged that uncertainty arising from events such as Brexit and the referendum on Scottish independence in 2014 had led to investment decisions being delayed.

Mr Bailey, who is approaching the first anniversary of his appointment to the role, said: “Well, let me be clear, I do not offer any view on Scottish independence. As the Governor of the Bank of England that is way beyond my competence and role.

“What I would say is this: I think there is well-worn relationship in economics between the level of uncertainty, whatever that may be caused by, and investment. In other words, if you are a business and you are facing conditions that you can regard as highly uncertain, if you can decide to put off an investment decision in the hope that by the time you come next to consider it there will be greater degree of certainty around the future, you have quite a strong incentive to do so.

“And we have seen obviously quite high levels of uncertainty in the UK over the last decade… with Brexit obviously, and I think we did see some evidence of that in the first Scottish referendum. I remember coming up to Scotland… and people talked to us about… putting off investment decisions to see what happens.

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“I am very, very clear [about] not offering any view on any issues on Scottish independence, so I am making a general point. There is a relationship between uncertainty and investment.”

Asked whether the surging rates of coronavirus would cause the Bank to consider further stimulus measures, Mr Bailey said it would “consider all the evidence” when the Monetary Policy Committee next meets in February. At that point, the Bank  would have a “new forecast” for the economy with the publication of its next Monetary Policy Report.

Mr Bailey appeared to be cool on the prospect of the Bank taking interest rates, currently set at a historic low of 0.1 per cent, into negative territory as a policy measure. He acknowledged negative rates were a “controversial policy” and “at first glance counter-intuitive”, as investors expect to receive a rate of return on deposits they lodge with banks, instead of having to pay for the “privilege”.

While he noted that in “simple” economic and mathematical terms there is nothing to stop it, “there are a lot of other issues with it”.

He said: “The transmission of this depends on the banking system. Banks do have to earn a rate of return. Negative interest rates complicate the rate of return because they put much more pressure on the so-called net interest rate margins. That in turn depends on how negative interest rates are passed through into the economy.

“If you do not pass them through the retail world, in either deposits or borrowing, that switches off part of the monetary transmission. One of the things we have to judge is are they then effective? That is something we spend a lot of time looking at.”

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Mr Bailey observed the pandemic has had an “uneven” effect on the economy. While there have been huge job losses for people who work in sectors such as hospitality, the level of savings held by people whose incomes has remained intact has increased, even though last year’s recession was “huge and severe” in terms of the impact on activity.

However, he said it was unclear whether people who have saved will unleash spending when the economic recovery comes, or whether they will continue to save for reasons of caution.

Mr Bailey said the unemployment rate is currently the “hardest” part of the economy to read.

Although official figures point to a nationwide rate of 4.9 per cent, and 4.2% in Scotland, Mr Bailey said “we think it is higher. Our best guess nationwide it is probably around 6.5%. It has risen.”

He said the unemployment picture is hard to judge partly because it is more difficult to ask people whether or not they are looking for a job amid the current restrictions, and because those attitudes are likely to be changeable. The furlough scheme, “which is a good thing, is also “masking” the picture, he said.

Mulling the outlook for the economy, he said the vaccine programme held the key to determining the return of a “fuller life”. He also noted it was important to not read too much into downturns past, and expressed the view that it was unlikely the economy would undergo the massive level of structural change that occurred in the 1980s and 1990s, when the UK made the painful transition from an industrial-based to a services economy. That process led to a huge structural unemployment and business failures in Scotland.

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Mr Bailey said: “I think it would be quite pessimistic to think we will see a repeat of that. I do not think that is what is going to happen. But there will be a job for policymakers to see how best we can bridge through that period, and use policy to smooth the effects and speed up the change that has to happen.

“We, the Bank of England that is, are at the lower end of the estimate of what I’m afraid very pejoratively often gets called scarring on the economy. And it is very important. It takes a long time to for some of these effects to work out, if you get more structural unemployment, for instance.

“I do not think the impact of Covid will cause a structural shift in the economy.”

“The UK economy has a high services component… and I am not sure that will necessarily change.”

He said the Covid crisis is the first “very big test” of reforms made to safeguard the financial services sector in the event of major shocks since the financial crash of 2008 and 2009, noting that “the banking system has so far come through well.”

“And that is important because it means they have continued to lend, particularly over the last year,” he added. “But we want them to go on lending.”

He stressed the importance of banks continuing to lend “even when the economy turns down, because that is in the best interests of the economy, but also the banks.”

“Having the banks contribute to exacerbate the downturn is a much more dangerous situation. We saw that during the financial crisis. So far so good on that front.”

By Scott Wright

THE Governor of the Bank of England has declared there is a “well-worn” link between political uncertainty and the appetite of businesses to invest, as he downplayed the likelihood of a move to negative interest rates.

Andrew Bailey declined to venture a direct opinion on the issue of Scottish independence, which has surged back to the top of the political agenda in light of Brexit and coronavirus, when asked whether the raging constitutional debate would weigh on business investment in Scotland.

But, speaking at a Scottish Chambers of Commerce webinar yesterday, he acknowledged that uncertainty arising from events such as Brexit and the referendum on Scottish independence in 2014 had led to investment decisions being delayed.

Mr Bailey, who is approaching the first anniversary of his appointment to the role, said: “Well, let me be clear, I do not offer any view on Scottish independence. As the Governor of the Bank of England that is way beyond my competence and role.

“What I would say is this: I think there is well-worn relationship in economics between the level of uncertainty, whatever that may be caused by, and investment. In other words, if you are a business and you are facing conditions that you can regard as highly uncertain, if you can decide to put off an investment decision in the hope that by the time you come next to consider it there will be greater degree of certainty around the future, you have quite a strong incentive to do so.

“And we have seen obviously quite high levels of uncertainty in the UK over the last decade… with Brexit obviously, and I think we did see some evidence of that in the first Scottish referendum. I remember coming up to Scotland… and people talked to us about… putting off investment decisions to see what happens.

“I am very, very clear [about] not offering any view on any issues on Scottish independence, so I am making a general point. There is a relationship between uncertainty and investment.”

Asked whether the surging rates of coronavirus would cause the Bank to consider further stimulus measures, Mr Bailey said it would “consider all the evidence” when the Monetary Policy Committee next meets in February. At that point, the Bank  would have a “new forecast” for the economy with the publication of its next Monetary Policy Report.

Mr Bailey appeared to be cool on the prospect of the Bank taking interest rates, currently set at a historic low of 0.1 per cent, into negative territory as a policy measure. He acknowledged negative rates were a “controversial policy” and “at first glance counter-intuitive”, as investors expect to receive a rate of return on deposits they lodge with banks, instead of having to pay for the “privilege”.

While he noted that in “simple” economic and mathematical terms there is nothing to stop it, “there are a lot of other issues with it”.

He said: “The transmission of this depends on the banking system. Banks do have to earn a rate of return. Negative interest rates complicate the rate of return because they put much more pressure on the so-called net interest rate margins. That in turn depends on how negative interest rates are passed through into the economy.

“If you do not pass them through the retail world, in either deposits or borrowing, that switches off part of the monetary transmission. One of the things we have to judge is are they then effective? That is something we spend a lot of time looking at.”

Mr Bailey observed the pandemic has had an “uneven” effect on the economy. While there have been huge job losses for people who work in sectors such as hospitality, the level of savings held by people whose incomes has remained intact has increased, even though last year’s recession was “huge and severe” in terms of the impact on activity.

However, he said it was unclear whether people who have saved will unleash spending when the economic recovery comes, or whether they will continue to save for reasons of caution.

Mr Bailey said the unemployment rate is currently the “hardest” part of the economy to read.

Although official figures point to a nationwide rate of 4.9 per cent, and 4.2% in Scotland, Mr Bailey said “we think it is higher. Our best guess nationwide it is probably around 6.5%. It has risen.”

He said the unemployment picture is hard to judge partly because it is more difficult to ask people whether or not they are looking for a job amid the current restrictions, and because those attitudes are likely to be changeable. The furlough scheme, “which is a good thing, is also “masking” the picture, he said.

Mulling the outlook for the economy, he said the vaccine programme held the key to determining the return of a “fuller life”. He also noted it was important to not read too much into downturns past, and expressed the view that it was unlikely the economy would undergo the massive level of structural change that occurred in the 1980s and 1990s, when the UK made the painful transition from an industrial-based to a services economy. That process led to a huge structural unemployment and business failures in Scotland.

Mr Bailey said: “I think it would be quite pessimistic to think we will see a repeat of that. I do not think that is what is going to happen. But there will be a job for policymakers to see how best we can bridge through that period, and use policy to smooth the effects and speed up the change that has to happen.

“We, the Bank of England that is, are at the lower end of the estimate of what I’m afraid very pejoratively often gets called scarring on the economy. And it is very important. It takes a long time to for some of these effects to work out, if you get more structural unemployment, for instance.

“I do not think the impact of Covid will cause a structural shift in the economy.”

“The UK economy has a high services component… and I am not sure that will necessarily change.”

He said the Covid crisis is the first “very big test” of reforms made to safeguard the financial services sector in the event of major shocks since the financial crash of 2008 and 2009, noting that “the banking system has so far come through well.”

“And that is important because it means they have continued to lend, particularly over the last year,” he added. “But we want them to go on lending.”

He stressed the importance of banks continuing to lend “even when the economy turns down, because that is in the best interests of the economy, but also the banks.”

“Having the banks contribute to exacerbate the downturn is a much more dangerous situation. We saw that during the financial crisis. So far so good on that front.”