Analysis: Economy would dodge bullet for now under fiscal deal

U.S. Senate Minority Leader Mitch McConnell (C) departs the senate floor with an aide after a senate vote in the early morning hours at the U.S. Capitol in Washington January 1, 2013.

Credit: Reuters/Jonathan Ernst

By Jason Lange

WASHINGTON | Tue Jan 1, 2013 2:52am EST

WASHINGTON (Reuters) - A deal worked out by U.S. Senate leaders to avoid the "fiscal cliff," was far from any "grand bargain" of deficit reduction measures.

But if approved by the U.S. House of Representatives, it could help the country steer clear of recession, although enough austerity would remain in place to likely keep the economy growing at a lackluster pace.

The Senate approved a last-minute deal early Tuesday morning to scale back $600 billion in scheduled tax hikes and government spending cuts that economists widely agree would tip the economy into recession.

The deal would hike taxes permanently for household incomes over $450,000 a year, but keep existing lower rates in force for everyone else.

It would make permanent the alternative minimum tax "patch" that was set to expire, protecting middle-income Americans from being taxed as if they were rich.

Scheduled cuts in defense and non-defense spending were simply postponed for two months.

Economists said that if the emerging package were to become law, it would represent at least a temporary reprieve for the economy. "This keeps us out of recession for now," said Menzie Chinn, an economist at the University of Wisconsin-Madison.

The contours of the deal suggest that roughly one-third of the scheduled fiscal tightening could still take place, said Brett Ryan, an economist at Deutsche Bank in New York.

That is in line with what many financial firms on Wall Street and around the world have been expecting, suggesting forecasts for economic growth of around 1.9 percent for 2013 would likely hold.

At midnight Monday, low tax rates enacted under then-President George W. Bush in 2001 and 2003 expired. If the House agrees with the Senate - and there remained considerable doubt on that score - the new rates would be extended retroactively.

Otherwise, together with other planned tax hikes, the average household would pay an estimated $3,500 more in taxes, according to the Tax Policy Center, a Washington think tank. Budget experts expect the economy would take a hit as families cut back on spending.

Provisions in the Senate bill would avoid scheduled cuts to jobless benefits and to payments to doctors under a federal health insurance program.

AUSTERITY'S BITE

Like the consensus of economists from Wall Street and beyond, Deutsche Bank has been forecasting enough fiscal drag to hold back growth to roughly 1.9 percent in 2013. Ryan said the details of the deal appeared to support that forecast.

That would be much better than the 0.5 percent contraction predicted by the Congressional Budget Office if the entirety of the fiscal cliff took hold, but it would fall short of what is needed to quickly heal the labor market, which is still smarting from the 2007-09 recession.

"We continue to anticipate a significant economic slowdown at the start of the year in response to fiscal drag and a contentious fiscal debate," economists at Nomura said in a research note.

In particular, analysts say financial markets are likely to remain on tenterhooks until Congress raises the nation's $16.4 trillion debt ceiling, which the U.S. Treasury confirmed had been reached on Monday.

While the Bush tax cuts would be made permanent for many Americans under the budget deal, a two-year-long payroll tax holiday enacted to give the economy an extra boost would expire. The Tax Policy Center estimates this could push the average household tax bill up by about $700 next year.

The suspension of spending cuts sets up a smaller fiscal cliff later in the year which still could be enough to send the economy into recession, said Chinn.

He warned that ongoing worries about the possibility of recession could keep businesses from investing, which would hinder economic growth.

"You retain the uncertainty," Chinn said.

(Reporting by Jason Lange; Editing by Eric Walsh)

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Analysis: Jeep attempts to go global - again

By Paul Lienert

DETROIT | Fri Dec 21, 2012 1:28pm EST

DETROIT (Reuters) - The 62-year-old Jeep brand is poised to get a sweeping multibillion-dollar overhaul that will expand the product range, boost its overseas presence and knit the fortunes of Jeep and U.S. parent Chrysler even more closely with those of Italy's Fiat SpA (FIA.MI).

Fiat, which took management control of Chrysler after the U.S. automaker's 2009 bankruptcy, plans to broaden the Jeep stable from four to at least six nameplates by 2016, Reuters has learned.

Three of those future Jeeps will be built on Fiat platforms, according to two industry sources familiar with Chrysler's and Fiat's future product programs, and several will share their underpinnings with companion models from Fiat and its premium European brands, Alfa Romeo and Maserati.

Fiat CEO Sergio Marchionne is masterminding the four-year retooling that is intended to establish Jeep as one of the Italian automaker's core global brands.

It is far and away the most ambitious effort to elevate the Jeep brand, which traces its roots to the iconic World War Two military vehicle and has had multiple owners over the past seven decades, including French automaker Renault SA (RENA.PA) and German automaker Daimler AG (DAIGn.DE).

"Jeep probably has the strongest global reputation of any brand inside the company - but it's never really been developed," said David Cole, chairman of Ann Arbor, Michigan, consulting firm AutoHarvest and a longtime industry analyst.

That has begun to change under Marchionne, who has been pushing for greater integration of the Fiat and Chrysler product ranges, while singling out Jeep for special attention and heavy investment.

INTERNATIONAL CITIZEN

The renewed focus on Jeep is paying off. U.S. sales through November are up nearly 16 percent, and Chrysler said the brand - now sold in more than 120 countries - expects this year to beat its previous global sales record of 675,000 vehicles in 1999. Nearly a third of those sales, about 218,000, will come from overseas markets.

To facilitate Jeep's global growth, Marchionne has decreed that virtually every future Jeep, except for the long-running Wrangler, will share its major underbody components with one or more Fiat group brands. A Chrysler spokesman declined to provide more specific details.

Marchionne this week announced that Fiat will spend $1.3 billion to build baby Jeeps alongside Fiat-branded siblings in 2014. The two small crossover vehicles share common chassis and powertrain components and will be exported from Fiat's Melfi plant to markets around the world - a new twist on Jeep's long-running international saga.

In Ohio, Chrysler is pouring $1.7 billion into its Toledo plant, parts of which date to 1910 and which once housed Jeep's original owner, Willys-Overland.

The Toledo factory next summer will begin turning out a new mid-size Jeep, a replacement for the now-defunct Liberty. The new model may revive the Cherokee nameplate and eventually will spawn a premium companion for Alfa Romeo, most likely in 2015, sources said. Both vehicles are aimed at global markets and will be derived from the same Fiat/Alfa Romeo architecture that underpins the 2013 Dodge Dart, they said.

In Detroit, Chrysler's Jefferson Avenue plant will begin building the facelifted 2014 Grand Cherokee in January and is slated to assemble an even larger, more luxurious seven-passenger derivative in 2014 that will resurrect another familiar Jeep name, Grand Wagoneer.

Earmarked for production in 2015, probably in Italy, is a more exclusive Grand Cherokee spinoff, the Maserati Levante, a premium product that Marchionne has been discussing publicly for more than a year.

With the new baby Jeep - it may be called Scamp - anchoring the low end of the range and the new Grand Wagoneer at the high end, the brand also is preparing to replace its slow-selling compacts, the Compass and the Patriot, with a single model in 2014, the sources said.

This as-yet-unnamed model, like the Liberty replacement, will be built on a Fiat platform and assembled in the United States. And, as with virtually all future Jeeps, it is intended to be exported around the world.

Chrysler designers and engineers also are working on replacements for the Wrangler and the Grand Cherokee for 2016-2017, the sources said.

Those two models - the Wrangler was introduced in 1987, the Grand Cherokee in 1993 - remain cornerstones of the brand in the United States, where Jeep sales this year are expected to reach 470,000.

KEEPING JEEP'S PERSONALITY

Analysts caution that Chrysler and Fiat need to be careful not to stray too far from the qualities - including rugged styling and a go-anywhere reputation - that have been part of Jeep's personality from the beginning.

"Jeep is one of the brands in Marchionne's treasure chest that must be protected, nurtured and grown," contends Jane Nakagawa, a former automotive product planner and now senior vice president of strategic planning for consultant interTrend Communications. "There's a lot more opportunity with authentic, yet differentiated product extensions."

While Wrangler and Grand Cherokee remain the best-selling Jeeps, it is through such new models as the Italian-built mini-crossover that Fiat and Chrysler hope to expand the brand's presence outside North America.

With a rich history, a diverse owner base and a name that is recognized around the world, Jeep is "the brand without borders," added Rebecca Lindland, director of research for IHS Automotive.

"Jeep is one of the few American brands with virtually no baggage," said Lindland. "It is a charismatic brand with global appeal."

Part of that appeal dates to World War Two, when the first open-top utility vehicles were developed and built for the U.S. military and quickly were dubbed "Jeeps." Willys, which continued civilian production after the war, trademarked the Jeep brand name in 1950.

Since then, Jeeps have been built in at least 20 countries on six continents, by a variety of manufacturers and licensees, including Renault, Daimler, Mitsubishi Motors Corp (7211.T), Kia Motors Corp (000270.KS) and Mahindra and Mahindra (MAHM.NS). And that does not count several smaller U.S. automakers - such as AMC, Willys and Kaiser Motors - that have long since fallen by the wayside.

Marchionne's evolving global strategy for Jeep has its unlikely antecedents in tiny American Motors, whose corporate parent, French automaker Renault, sold it to Chrysler in 1987, after deciding it could not afford to support a global marketing effort to promote Jeep.

Under Chrysler, Jeep production has been centered mainly in the United States, with exports shipped to all corners of the globe.

"This is not new territory - Renault and AMC planned to take Jeep global in the mid-1980s," according to Bill Chapin, a former executive who headed international marketing for the Jeep brand after AMC formed the Beijing Jeep joint venture in China.

The concept of Jeep as a global brand "is still as valid today as it was then," added Chapin, who is now president of the Automotive Hall of Fame in Dearborn, Michigan. "Hopefully, Fiat has the wherewithal to pull it off - to expand the product range and the reach, and still maintain the 'Jeep-ness.'"

(Additional reporting by Jennifer Clark in Milan; editing by Tiffany Wu and Matthew Lewis)

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Analysis: In ICE-NYSE deal, one CEO steps back, the other rises

By John McCrank and Jonathan Spicer

Fri Dec 21, 2012 1:11am EST

n">(Reuters) - Duncan Niederauer, the chief executive of New York Stock Exchange operator NYSE Euronext, once boldly proclaimed that his company could not be acquired.

Last year, even when Niederauer was prepared to sell his company to Deutsche Boerse, he insisted that he be chief executive of the combined company. The deal ended up being quashed by German regulators.

But with the agreement by IntercontinentalExchange to buy NYSE Euronext for $8.2 billion, Niederauer has accepted he will have to at the very least play second fiddle. He will become president at the combined company, while still running the New York Stock Exchange, and report to ICE CEO Jeff Sprecher.

"In a sense he must be very frustrated because some of the big things he was trying to do did not work out," said Andre Cappon, president of CBM Group, a New York-based consultant for global exchanges.

To an extent, the world may have left Niederauer behind. His expertise was in stock trading, a business that now has razor-thin margins and is increasingly left to computers.

Sprecher, on the other hand, has ascended as derivatives have become a key part of financial markets and the financial crisis made listed derivatives relatively more important.

Born in Indiana near the Kentucky border, and raised in Madison, Wisconsin, he has a down-to-earth aura that belies his ambitious type-A personality, say people who know him.

Sprecher has not met with constant success, but when something goes wrong, he moves on.

"He's not afraid to fail," said one person who knows Sprecher well.

Among his misses: a failed bid to buy the Chicago Board of Trade in 2007, not to mention a failed joint bid for the NYSE with Nasdaq OMX Group Inc.

He made his move for the CBOT at the annual meeting of the Futures Industry Association, in Boca Raton, Florida, where CME Group officials had expected to deliver a progress report on their planned acquisition of their smaller rival.

Sprecher slipped the formal offer under the hotel doors of CBOT Chairman Charles Carey and CBOT CEO Bernard Dan, at about 6:30 in the morning of the conference's first day.

CME Group later raised its bid for CBOT and clinched the deal in mid-2007 - but Sprecher would still finish the year with two key acquisitions, the New York Board of Trade commodity market and Canada's biggest grains exchange.

This summer both Sprecher and Niederauer bid for the London Metals Exchange and lost. Within four months they were talking to each other about a much larger deal.

LETTING GO OF EGO

There was some bad blood between Sprecher and Niederauer last year, when Sprecher's ICE was part of the group that made an unsolicited bid for NYSE Euronext.

NYSE Euronext was instead focused on a different deal: selling itself to Deutsche Boerse. Sprecher admitted in an interview with Reuters that he tried to wreck the Deutsche deal by "calling out every wart and pimple" on the transaction.

The two men stopped talking for about six weeks.

But after ICE posted good fourth-quarter results in February, Niederauer extended an olive branch with a surprising three-word email to Sprecher: "Hey, great quarter."

"He and I had a preexisting friendship and I wondered if it was going to survive my trouble making," Sprecher told Reuters. Then the email arrived.

"He was very magnanimous and so I knew that he saw through what I was doing and we were still very cordial."

Niederauer took over as NYSE Euronext CEO at the end of 2007, just after his predecessor, John Thain, had completed the landmark deal to buy Franco-Belgian Euronext.

After a 22-year career at Goldman Sachs, mostly in equity trading, and just nine months as head of NYSE's trading operations, he took control just before the 2008 financial crisis triggered a seismic shift in the exchange world, one that seemed ill-suited to his background.

Equity investors, burned by scandals and volatility, were trading less and less; meanwhile new regulations would drive more derivatives onto exchanges like ICE and CME.

The answer, Niederauer thought, lay in Deutsche Boerse. But when regulators nixed the deal in February this year, he quickly laid out a new strategic plan for shareholders: clearing and technology - two areas in which ICE already excelled.

By June, Niederauer was saying it was "make-or-break time" for NYSE's nascent U.S. futures operation, which was clearly failing to thrive in the shadow of established rivals.

In working together at the merged venture, Sprecher and Niederauer may each find a comfortable way to co-exist, each playing to his respective strength, some say. But several people, including a NYSE investor and a board member of a rival exchange, questioned whether the partnership can last.

In an interview, Niederauer said he would remain at least through 2014 as an "important senior member" of Sprecher's management team.

He added: "People get too caught up in titles. Let's just worry about making it work and my guess is that if it's still fun for both of us in 2014, or 2015, or whatever, we will keep doing it."

(Reporting By John McCrank, Jonathan Spicer, Josephine Mason and Jessica Toonkel in New York, and Ann Saphir in Chicago; Writing by Jonathan Leff and Dan Wilchins; Editing by Steve Orlofsky)

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Analysis: Boehner has few options in fiscal cliff mess

U.S. House Speaker John Boehner (R-OH) speaks to the media on a ''fiscal cliff'' on Capitol Hill in Washington, December 20, 2012.

Credit: Reuters/Yuri Gripas

By Richard Cowan

WASHINGTON | Fri Dec 21, 2012 3:34am EST

WASHINGTON (Reuters) - Now that House Speaker John Boehner's "Plan B" for addressing the "fiscal cliff" has crashed and burned, the top U.S. Republican appears to have two remaining options - wash his hands of the entire matter or negotiate a compromise with Democrats that could abandon scores of his fellow Republicans.

The Republican rank and file and Democrats may face an equally stark choice: work together for a change, or plunge together off the cliff.

Boehner tried to ram a "fallback" plan through the House on Thursday - a relatively tiny tax increase on millionaires and billionaires - and failed. His rambunctious Republicans, who see opposition to all tax hikes as a matter of bedrock principle and of political survival, refused to go along.

President Barack Obama and his Democrats who control the Senate take the opposite view - tax hikes on the wealthy are a condition for their support of a fiscal cliff bill. If there is to be a resolution it will largely depend on an improbable scenario - Democrats in the House teaming up with less militant Republicans to back away from the fiscal cliff.

Compromise has been out of style in recent years, and many think it could require some prodding from the markets.

"At this point, I only see one route to avoiding the cliff, a replay of the TARP debacle in 2008," said George Washington University's Sarah Binder, an expert on Congress. In September 2008, the House defeated the bank bailout bill and the market collapsed, prompting a terrified lawmakers to reconsider and pass it.

"In this case, a harsh market and public reaction would be needed to force the hand of the speaker to negotiate a deal that can pass with Democratic votes," she said.

"If the GOP takes a beating in the headlines and the market tanks, I suspect a good number of rank-and-file GOP will demand that the speaker go back to the table. But absent whiplash from the markets and voters, I suspect it's over the cliff we go."

For the time being - or at least the 11 days until the automatic tax hikes and spending cuts are triggered - the House is in disarray and no deal to avert the fiscal cliff is in sight.

While the House in recess for a Christmas break that is likely to last at least until December 27, Boehner must decide whether to move any further in Obama's direction and agree to tax increases much higher than his own proposal that so angered his fellow Republicans on Thursday.

The Ohio Republican also might have to settle for fewer long-term spending cuts than he had hoped for.

WALK ON BY

Boehner's only other apparent option - one that he hinted at late on Thursday following the collapse of his bill - would be to walk away and leave the problem on Democrats' doorstep.

"Now it is up to the president to work with Senator Reid on legislation to avert the fiscal cliff," Boehner said in a statement referring to Senate Majority Leader Harry Reid.

But in a closed-door session before that statement, Republican lawmakers said Boehner told them that he would at least try to work out something with Obama.

Either way, Boehner faces the possibility of having to battle not only Democrats for the next two years, but also his own membership on major bills.

"We have people (Republican lawmakers) who felt like they had to stand on the principle ... they couldn't vote for anything (that raised any taxes). I don't quite understand it," lamented Representative Buck McKeon, the powerful chairman of the House Armed Services Committee, who oversaw passage of a $633 billion defense spending bill for 2013.

"If you don't have the votes, you can't move forward," McKeon said of the Plan B fiscal cliff bill.

Representative Steven LaTourette, a moderate Republican who is retiring at year's end, told reporters that Thursday's legislative defeat - and public relations failure - will not stop Boehner from being re-elected House Speaker on January 3. "Name one member who opposes him," LaTourette challenged reporters.

Firing Boehner, LaTourette said, would be "like saying the superintendent of the insane asylum should be discharged because he couldn't control the crazy people."

Nonetheless, two years into his stint as Speaker, Boehner still has not found the right formula for corralling his Republican majority, especially the Tea Party conservatives whose victories in 2010 helped Republicans wrest control of the House. However, he has taken steps in recent weeks to punish a handful of uncooperative Republicans.

Since unveiling his plan on Tuesday, several conservative groups, including the Heritage Foundation, waged a spirited effort to kill the measure.

Those groups, LaTourette said, had been "making their phone calls, and they're bombing people" with pressure to vote against the bill. That, he added, "makes people nervous" about primary election challengers being recruited in 2014 by outside groups to defeat Republican lawmakers who vote for any tax increase.

"I doubt his speakership is in trouble," said American Enterprise Institute scholar Norm Ornstein, "The big question is whether, and when, he is willing to bring up a bill that will require more Democrats than Republicans to pass."

(Reporting By Richard Cowan. Editing by Fred Barbash)

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Analysis: Central bankers rethink their devotion to slaying inflation

Bank of Canada Governor Mark Carney views some historic gold coins dating back to before World War I, at the Royal Canadian Mint in Ottawa November 28, 2012.

Credit: Reuters/Blair Gable

By Jonathan Spicer

NEW YORK | Thu Dec 20, 2012 10:04am EST

NEW YORK (Reuters) - A subtle shift in monetary policymaking is afoot with a new generation of central bankers, striving to secure global economic recovery, prepared to challenge the old doctrine of inflation-fighting at all costs.

Mark Carney, the governor of the Bank of Canada and soon-to-be head of the Bank of England, may or may not have intended to spark a high-level debate last week over how diligently central banks should fend off inflation.

But he did just that with his speech in Toronto on the BoC's flexible approach to prices, and his musings on alternative approaches to policy that the Canadian central bank had considered but dismissed.

Within two days, Britain's finance minister, two BoE policymakers, and numerous economists had weighed in on what Carney's comments meant for the country and for the future of central banking.

The sharp reaction reflects unease with a change in the way the world's major central banks approach policy in an era of slow recovery from world economic crisis.

Policymakers from the U.S. Federal Reserve to the Bank of Japan have reconsidered or relaxed their inflation targets -- long the raison d'etre of monetary policy -- and have given more emphasis to economic growth, even if that is not an official mandate.

"They have reduced their slavish devotion to the sole goal of inflation targeting," said Carl Tannenbaum, a former Fed official who is now chief economist at U.S. asset manager Northern Trust.

No central banker is going to tolerate an inflation spike in order to boost employment or foster more growth.

Policymakers have also largely dismissed some of the more radical alternatives to achieving their goals, most notably targeting levels of nominal gross domestic product (real GDP plus inflation).

Yet with the financial crisis having starkly exposed central banks' failure to stave off danger, and policymakers having responded by flooding world markets with trillions of dollars in cheap funding, a small run-up in inflation may no longer be the anathema it once was.

TRAILBLAZING IN NORTH AMERICA

In the world's largest economy, Fed Chairman Ben Bernanke has unleashed some $2.5 trillion in asset purchases in the last few years to boost hiring and economic growth, squarely focusing on the employment side of the U.S. central bank's dual mandate.

His approach differs to that of his veteran predecessor Alan Greenspan. The same goes for Mario Draghi who took over from Jean-Claude Trichet at the ECB and it looks like Carney, replacing Britain's Mervyn King, fits the same pattern.

The Fed last week tied low interest rates to a drop in the jobless rate to 6.5 percent -- it stood at 7.7 percent last month -- as long as inflation did not threaten to top 2.5 percent.

The unprecedented move may represent the culmination of its departure from the inflation-centric model pursued by former Fed chairmen Greenspan and Paul Volcker and gave a clear signal that it would tolerate inflation above its 2 percent target if that was the cost of getting more Americans back to work.

Eric Green of TD Securities, a former New York Fed economist, wrote that "Bernanke has relaxed the inflation constraint", effectively raising the Fed's core inflation target over time from 1.75 percent to 2.5 percent.

North of the border, the Bank of Canada has long had an inflation target of 2 percent within a range of 1 to 3 percent.

But unlike past BoC governors, Carney, 47, has emphasized the idea of "flexible targeting" in which inflation could be allowed to stray from the target for longer than would normally be tolerated in order to stabilize financial markets or the economy.

Carney said earlier this month that the BoC explored the idea of changing its inflation targeting mandate altogether but decided that was too risky.

He stressed he was not dropping hints about his plans for Britain yet BoE policymakers were quick to push back on any notion the country should change its approach to policy.

Paul Fisher, the BoE's executive director for markets, said Britain should be wary of changing the central bank's 2-percent inflation target and had no need to adopt the longer-term commitments its North American counterparts have made on interest rates.

But while BoE Chief Economist Spencer Dale warned "there is no free lunch" when it comes to changing the central bank's target, British finance minister George Osborne surprised some when he welcomed Carney's opening of the debate.

"If you want to change the regime you have to make a pretty strong case for doing so," Osborne told members of parliament.

LAST OF THE INFLATION FIGHTERS

In July, Carney will replace King, considered among the last of the old guard of inflation-fighting central bankers -- despite mixed success in that regard -- which also included BoJ Governor Masaaki Shirakawa and former ECB head Trichet.

Draghi, who succeeded Trichet last year, has been careful to stick to the ECB's price stability mantra, which is enshrined in the EU treaty and fiercely defended by Germans who are still haunted by the memory of hyperinflation in the 1920s.

Yet he has also flooded the financial sector with more than one trillion euros this year and pledged to buy euro zone government bonds in whatever amounts are needed to shore up the currency bloc.

Two hardline ECB policymakers, Axel Weber and Juergen Stark, resigned last year over the bank's previous bond-buying program. The pair said they felt it strayed into the realm of fiscal policy and could ultimately pose inflation risks.

In Japan, Shirakawa is under unusually explicit pressure from incoming Prime Minister Shinzo Abe to boost the BoJ's inflation target to 2 percent, from 1 percent, to help battle the deflation that has mired the country for the past 15 years.

Abe's party was swept to power on Sunday in part on a pledge of "unlimited" monetary easing to achieve higher inflation.

In a private meeting on Tuesday, Shirakawa was said to have sat in silence as Abe reiterated his request for the BoJ to boost its inflation target. The BOJ duly delivered its third shot of monetary stimulus in four months earlier on Thursday.

Masaaki Kanno, a former colleague of Shirakawa at the BOJ and now chief economist at JPMorgan Securities in Japan, says Shirakawa will be the last "normal" BoJ governor, one who worries about the risks posed by printing money.

"There are more and more people in Japan who want deflation to be eliminated and feel that the BoJ should be forced to use its 'magic wand' to create inflation," Kanno said.

"The only option left for Japan might be for the BOJ to print money by buying more bonds," he added. "If that's what the public wants, (Shirakawa's) successor will probably have to go down that route."

(Additional reporting by Louise Egan and Randall Palmer in Ottawa, Leika Kihara in Tokyo, David Milliken in London, and Paul Carrel in Frankfurt. Editing by Mike Peacock)

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Analysis: Next Bank of England chief Carney is more bark than bite

Bank of Canada Governor Mark Carney speaks to the business community during a luncheon in Toronto, December 11, 2012.

Credit: Reuters/Mark Blinch

By Louise Egan

OTTAWA | Thu Dec 20, 2012 12:21pm EST

OTTAWA (Reuters) - Musings on unorthodox monetary policies are giving incoming Bank of England Governor Mark Carney a "radical" image before he even sets foot in his future home, but his record as head of Canada's central bank reveals him as a free-thinker on paper rather than in practice.

At three crucial crossroads during his mandate at the Bank of Canada, Carney talked about delving into bold, new frontiers of monetary policy. But when each decision time came, he opted for the more conservative path.

Carney, governor since 2008, oversaw an exhaustive research program at the Bank of Canada on possible alternatives to the bank's 21-year-old, inflation target, only to decide a year ago to stick to it for another five years.

With interest rates at rock bottom at the height of the global crisis, the bank published a plan for printing money, otherwise known as quantitative easing, but unlike his United States and UK peers Carney chose never to use that tool.

The decision surprised markets, even though Canada's economy was more robust than others and its banks never needed bailouts.

And for all his talk about using monetary policy to prevent asset price bubbles, it was the finance minister, not the central bank, who acted to cool an overheated housing market.

"His successes or imaginative approach was mostly in the financial sphere here, rather than a real clear break in monetary policy," said Mark Chandler, head of fixed income and currency strategy at RBC Capital Markets.

"So I think he'll spend most of his time (in Britain) dealing with how to fix the banking system," he said.

Britain's unprecedented appointment of a foreigner to head its central bank came as a shock to many in Canada and Britain even as British finance minister George Osborne hailed him as "the outstanding central banker of his generation".

Carney, who starts his new job on July 1, is most highly regarded for his work on global financial regulatory reform.

In his first speech crafted with a British audience in mind, on December 11, Carney stirred controversy by saying that, in times of crisis, central banks might consider targeting nominal gross domestic product, instead of inflation.

BRITAIN WORRIES, CANADA SHRUGS

The remarks sparked a flurry of warnings from BoE officials and British newspapers dubbed his ideas "radical".

Osborne welcomed the discussion but suggested the bar for change was high.

Bank of Canada-watchers simply shrugged, given that Carney mused on similar lines in November and February of this year.

"It's more of an academic approach where he is simply reviewing all the opportunities just to give a fuller understanding of the literature as opposed to advocating one approach over another," said David Tulk, chief Canada macro strategist at TD Securities.

Carney stressed several times that he was not recommending anything for the Bank of England, but listing policy options available to any central bank that has lowered interest rates to zero, with nominal GDP-level targeting the most extreme example.

The BoC's "wonky, somewhat dreary research" on alternatives to its 2 percent inflation target could provide lessons to other countries, he said, although the Canadian central bank studied price-level targeting rather than nominal GDP targeting.

Under price-level targeting, a central bank would aim for a numerical level in the consumer price index while nominal GDP-level targeting looks at both GDP and inflation. In both cases policy makers must take past deviations from the target into account and try to make up for them, while inflation targeting looks only at the future.

The Bank of Canada launched a research project into the merits of price-level targeting in 2006. In November, 2011, after years of discussions and dozens of papers, it decided the drawbacks were too great and the concept would confuse people.

"The bank has had success with inflation targeting. It has stabilized inflation... So why mess with success?" said Paul Ferley, deputy chief economist at Royal Bank of Canada.

To his credit, Carney has put some creative ideas into practice. He is best known for preceding the U.S. Federal Reserve in making an explicit commitment to keeping interest rates low for an extended period.

As early as 2009 he sang the praises of "flexible" inflation targeting, which the BoC now espouses and which means tolerating inflation straying from the target for longer than usual in order to prevent financial or economic instability.

LET'S NOT EASE

Carney was also one of a global club of central bankers talking openly about quantitative easing, and in April 2009 the bank laid out a detailed framework for unconventional policy that included asset purchases.

The market fully expected a first round of quantitative easing, given that the Bank of Canada had run out room to cut interest rates that were already at 0.25 percent.

But to most people's surprise on decision day, he issued the commitment to hold rates low until mid-2010 and left it at that.

"There was some expectation at least going into that period that the Bank of Canada would pursue outright quantitative easing, or maybe some form of credit easing. What they did was more appropriate, in our view, for the economy," said Tulk.

Likewise, Carney has frequently reminded Canadians that he may need to hike interest rates to curb alarmingly high household debt, which implies taking his eye off inflation for a period to pursue the target of financial stability.

But some say his words ring hollow after four years of rising debt and four separate government interventions in the mortgage market.

"At this point to be fair, they've relied a lot on jawboning and if ultimately that jawboning was expected to cool the acceleration of debt, it didn't," said Chandler.

(Reporting by Louise Egan; Editing by Leslie Gevirtz)

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