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Good Luck Mark Carney, You'll Need It

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It wasn't that long ago that Canada saw one of its more publicly visible chartered bank CEOs leave the nest to take the reins of a major UK financial institution. That individual was Matthew Barrett, then the CEO of BMO, who went to lead Barclays PLC.

Many years later, after Barrett's tenure was over, Barclays hit more than a couple of setbacks and the bank's stature today is diminished relative to its grander days in the 80s and 90s. Today we heard of yet another Canadian banker export to the UK as the country's Chancellor announced that the head role at the Bank of England would go to none other than the current Bank of Canada Governor, Mark Carney.

Like its European cousins, the UK has faced and continues to face major economic headwinds, with limited latitude on either the fiscal or monetary policy fronts. Sir Melvyn King -- the present Bank of England Governor -- has not exactly performed terribly in the aftermath of the 2008-1, but he
hasn't been a monetary policy poster boy either.

In particular, the BoE's implementation of non-traditional policy tools (like bond buy backs) has not been enough to counter the drag on domestic demand growth in the UK. While the third quarter pop in GDP of 1 per cent was a welcome surprise, it followed three consecutive quarters of contraction and early indications for retail spending so far in Q4 suggest the likelihood of a return to modestly negative GDP growth.

Meanwhile inflation remains stubbornly high, with headline retail inflation running at 3.2 per cent and core CPI (excluding food and energy) inflation at 2.6 per cent. Both are not as high as we've seen this cycle (headline retail inflation got up to 5.6 per cent in September of last year, for example), but it limits what the BoE can do with monetary policy if it doesn't want to lose the market's confidence in its ability to control inflation.

Let's put it another way: Over the past 20 years, retail inflation in the UK has averaged 2.8 per cent, with real GDP growth averaging 2.6 per cent on a year-over-year basis. On top of all this we have a Deputy Governor at the BoE (Paul Tucker) who is currently caught up in the Libor rate setting scandal revealed this year.

As for Carney, the track record has been impressive on the inflation front. Over the same 20-year period, Canada's headline inflation rate has averaged about 1.9 per cent, but average annual real GDP growth has been 2.7 per cent. With inflation now barely above 1 per cent, there is plenty of room for the Bank of Canada to cut its overnight rate target from the present 1 per cent mark should economic conditions sour.

Let's be clear. The Bank of Canada hasn't been perfect on policy and has often been criticized on flip-flopping with respect to its projections and guidance. That hasn't deterred global investors from shifting capital into Canadian securities on the prospect of low-inflation growth over the medium-term. The bet is that Carney can wave the same magic wand for the UK, though it's going to take more than a doctorate from Oxford to overcome the relatively larger challenges facing that country versus Canada, with its proximity to a troubled Eurozone.

Given the leadership role Carney has taken at the G20 (head of the Financial Stability Board) and strong working knowledge of global capital markets, most assume he is up to the challenge even though he was not favoured for the BoE's lead job (Tucker was odds on favourite). The bigger issue, however, is that Carney and the BoE are about to take on an increased financial sector oversight role as a new Prudential Regulatory Authority set up within the walls of the BoE prepares to replace the current Financial Services Authority. All we can say is good luck Mark.

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