How Mark Carney Gave the U.K. Government a Helping Hand

Persistently loose monetary policy should help George Osborne sleep easier in an election year

by Tom Beardsworth

Mark Carney, governor of the Bank of England.

Simon Dawson/Bloomberg

What should George Osborne do with 61 billion pounds ($91 billion)?
That's the happy conundrum facing the U.K. Chancellor of the Exchequer at the start of 2015, according to a Bloomberg Intelligence report. With the Bank of England and fellow central banks signaling to investors that any interest-rate increases will be limited or even nonexistent in 2015, U.K. gilt yields have halved in a year, touching record lows. Borrowing is getting cheap, fast.
The resulting saving amounts to as much as 30 billion pounds in lower borrowing costs by 2018-19 compared with the government's forecasts last March. The cumulative savings between now and then could reach 61 billion pounds—which is what the U.K. government is spending this year on defense and transport.

With an election pending in May, that could
offer Osborne and Prime Minister David Cameron scope to woo voters with tax cuts, which they have been able to deploy only sparingly since 2010 as the government battled to reduce its budget deficit.
Here's what the report's author, Bloomberg Senior Economist Jamie Murray, says.

"Osborne will undoubtedly trumpet lower borrowing costs as a sign that Mr Market is rewarding Conservative fiscal rectitude. In fact, the electorate mostly have Bank of England Governor Mark Carney to thank. Almost all of the fall in the government’s borrowing costs in 2014 can be explained by lower expected policy rates, with seemingly little attributable to falling risk premia."

And here's the chart.

Source: Bloomberg Economics

It shows that well over half of the decline in 10-year gilt yields over 2014 is accounted for by "lower expected real policy rates."
As ever, there's a dissenting view. Several economists think a rise could come sooner than markets expect, which could limit the extent of the cheap borrowing bonanza.

Source: Capital Economics

Consider the decision-making dynamics of the BOE's Monetary Policy Committee since Bank independence in 1997, as Capital Economics did last month. MPC majorities for interest-rate rises tend to form quickly—and not necessarily with a gradual strengthening of the minority caucus in the months beforehand.
For now, traders are still betting that the MPC won't vote to raise base rates from their record-low 0.5 percent for well more than a year. That's all welcome news for whichever party is in government later in the year.