Stuck between Truss and a hard place

calm and carrying on. I usually just say it's like it's really without the good weather, don't worry, you'll get through it, and the good food, it's not so bad. But now I say, well, come on my podcast or listen and then come on actually and talk about it and subscribe. And actually, massive shout out to the person on the left at my dinner on Sunday who got his phone out and subscribed. We love love more people

like that. Yeah, everyone we meet sign up to in the City listening rate as well and rates with five stars. We got so many points from our producer just now, it's just she's funny. I'm Franci Laqua and I'm David Merritt, and this is in the City Bloomberg's podcast connecting you to the stories and the voices at the heart of the City of London, and this week we spoke with Howard Davies. He is the chairman of the board of

Directors of nat West Group. Previously he was Director of the London School of Economics, the Chairman of the UK Financial Services Authority, and Deputy Governor of the Bank of England, amongst other roles. Sir Howard, thank you so much for joining us. When you look at the Bank of England, when you look at guilt and market mayhem, what exactly is going on? Well, the bank is in a difficult spot.

I think that's clear because we're in a slightly strange hiatus period where you've had a government announcement of a direction of fiscal policy, but you haven't had the details. And then you've got in the background people like the Institute of Fiscal Studies yesterday producing their Green budget saying there's a gap of sixty billion pounds. So people are focusing on that gap and saying how's that going to

be filled? And in the meantime that's creating an environment in which the volatility of sterling assets has been very unusually high and the Bank of England is having to try to manage that through now the Bank of England can't fill the sixty billion hole, but it can for financial stability purposes try to manage the extreme volatility and try to prevent it cascading over into real markets and the security of people's pensions. And that's what they're trying

to do. But I mean it's an imperfect operation because of the unusual circumstances. The messaging of the Bank of England has not been optimal, hasn't it. I mean we've gone from quantitative easing too tightening to easing back again and we're calling it quantitative confusion. I mean, is it is it their fault or is it just the situation they find themselves in. Well, my own view would be that it isn't fundamentally their fault because as I've explained them,

you know, they're in an unusual period. No one would write this script if if you were at a at a central bank, and so I think one has to have some sympathy with them trying to react to a very very fast changing environment. And so i'm personally but then this is maybe because you know, you can take the man out of the central bank, You can't take the central bank out of the man. So I'm, you know,

congenitally more sympathetic to the Bank of England. But it is the case that they were a bit slow to Titan and that hasn't helped I think, And I that was a few I took eight year or so ago. And it is true also that the Bank of england current shape is a bit confusingly engineered, I think for people outside to understand. So is there a credibility problem for the Bank of England today or is it just the bank saying I don't want to get dragged into

this political mess. I don't think there's a fundamental credibility problem in my view. I think that people appreciate the power of the central bank, but they also appreciate that the central bank cannot create a fiscal policy. That's for the government. So it can act to try to calm markets while they wait for a fiscal policy. But that's a chicky posture to be in. But I fundamentally don't

think it's a problem of the ultimate bredibility. Sounds like you're saying, has someone who's been there and been in the room that there's a structural problem with the Bankonglian and you know, let's trust to talked about the mandate, that's one question. But we've got these two different committees. Do you think there needs to be an overhaul? And all this confusion and the upheaving the market shows that actually it's time to have a rethink of how fundamentally

how the Bank of England operates. Well, the logic of what was done, and this this was all done by George Osborne, so it's not not list Trust, it's not the Bank of England itself. The logic was pretty clear that you made the Bank of England once again the banking regulator, and you gave it an overall financial stability objective which people said was not clear enough in the last global financial crisis. So this structure is a response to the global financial crisis. Okay, And until now people

have said, well that's that's fine. You know that sort of has has worked, and you know we haven't had another anymore, right, I mean historic moves in the guilt market. Yeah, but then this, this is a very unusual set of circumstances and now I'm personally reluctant to conclude that that means the structure is shot. We love changing structures in this country, you know, we just love it. We did it.

Very few people actually change their regulatory structure after the global financial crisis, even though many countries had equal meltdowns, but they left the structure the same. We just love moving the deck chairs, reorganizing institutions. And so I'm very reluctant to say that because of this highly, highly unusual situation, you know that that should be used as a reason to change the structure of the Bank of England. That

strikes me as being an order logic. But so how is this a power struggle then between the government and the Bank of England And are we going to see just two weeks of possible mayhem volatility in the markets until we know what the fiscal plans of the new government. I don't see it as a power struggle between the two because they each have their own responsibilities. The problem is that one of them, you know, there's a gap

and there isn't a fiscal framework. But at the moment there we don't know exactly what it is because we've got a declaration of intent, but we have clearly a gap. Government doesn't deny that there is clearly a gap, and then other people are coming in with helpful ideas about how it might be filled, but nobody knows what they are. So in the meantime, the Bank of England is having to sort of block and tackle dealing with the symptoms of uncertainty. But I don't I don't see that's a

power struggling. If you're on the on the MPC now, and you mentioned before that there were possibly a little late to raise rates, I mean, how high would you be recommending rates need to go to stabilize situation? Well, I wouldn't. I mean about the The MPC does not, which I was a member of briefly, But the MPC does not make that kind of forecast for the longer term.

I mean, I think that on the short term, I would be recommending a pretty large jump, you know, at least a seventy five b jump, because I think the perception is that we're a bit behind the game and that inflation is becoming too embedded. The inflation forecasts other people are coming out with suggest that we are going

to have embedded inflation for longer than other people. So I'd be wanting to bang up As for how far you get, I think you have to watch the reaction market reaction to that if you get the pension funds. So the idea of the Bank of England removes the axed up on Friday, does it think the bank that they're ready for it? Would they take a gamble and saying well, actually we don't know what happens, but we

need to do it. Anyway you were talking about, you know, the backstop of the backstop which means that they could fund themselves. I don't know whether they go to shadow banking instead. As to whether they Bank of England thinks that they're ready, I mean, I think it was inherent in Andrew Bailey's statements last night in Washington that he doesn't think that they are yet ready, but he thinks

they could be by the end of the week. Because what he said was you've got to get disorganized and you have to ensure that your liquidity problems are resolved in this window that we've given you to come along and get this liquidity problem solved. So I think, no, he doesn't think it's solved yet, but yes, he thinks it could be solved by the end of the week.

You know, I would always say that if they need to do something else, they'll do something else, because they won't just say, oh, well we tried that policy, it did work. There's now the markets internal again that we're just going to sit back and say I told you so. That's not the way a central bank would operate. But this particular facility, which was targeted at a particular problem in the LDI market, I believe it's going to end

on Friday. There are other things they've done, of course, however, which could carry over and still help the market. But we're not really seeing the full impact, are we of what's happened to these funds. You know, they're having to to raise to sell assets. That's going to ripple through markets in sort of unexpected ways, isn't it. And I think the scale of the shift in markets is has been unprecedented. I mean, what is the what is the

fallout going to be? Yes? Well, first of all, I think it's important to note that this isn't a solvency crisis for pension funds. It's a liquidity crisis. Second thing to notice that the facility has not been massively used, which does suggest that this was you know, focused on on a smallish number of it's not as bad as it doesn't look to us to be as bad as it as it is being presented, but it has produced

significant market moves. Um now my own view, but as I can't prove this is that to some extent those market moves are really reflecting a longer term uncertainty about the fiscal position and just the amount of funding that there's going to be from the government in that market. And it's not surprising that the guilt market should react to the fact that it looks as if the government's going to be pumping out guilts on a much larger scale than before. And so you know the price has adjusted.

What you know, that happened rather suddenly, which is a bit of a puzzle. But then I'm afraid you know, that's the way markets to the market is in an in an appropriate way, you think, for where we're going to be as an economy in the coming year. It's done it rather suddenly. But I think it's quite hard to say that the gum five year guilts at four point seven or whatever is an unreasonable price given the scale of the funding that the government is going to

be pushing through. That market. I mean, I can understand that. So how are you seeing any signs of distress amongst your your customers be individuals or bank or company? Very small? I mean sometimes people surprised, and indeed internally, you know, when I get the briefing saying no, no, no no, no, I say, you shure, you know, I don't want to go out there and say but no that the answer is that it is. It is early days, and but

in the mortgage market, not much sound distress. But as we might come on to explain, that's because most people are on fixed rates. Hasn't happened changed from from the last time, which is a significant disclosi. I just switched my networt mortgage. I'm afraid my five was coming to an end to the Halifax, which was oftening, But I did it. I did it, so how it's going to what I did a month ago? But you know it is I feel like I've dodged a bullet, right, and

a lot of people haven't. Well, that's what I mean. At the moment of our mortgages are fixed rate eight percent standard variable that our average the average residual maturity of these mortgages is two years and nine months. Therefore you can work that out. I can't instantly in my head, but I mean, you know, roughly a third of them are going to be coming up, So the incidence of this distress in mortgages is going to be very uneven.

So one of the things I don't think anyone really thought a particularly is what happens in a fixed rate mortgage environment when there's a sudden change in rates. You're also saying out of was it two weeks ago that a lot of the banks had to pull some mortgages or some of the banks you didn't pull mortgages? Is that because you stress tested to a higher level. I don't completely know that. We do stress to a pretty

high level. Actually, it's a sort of six or seven percent is what we do when we when we lend to people, we say, well, supposing the rights for six could you still afford this? Uh? And so our loan to valuation rate is usually about you know, most of an average, it's something like in the fifties, actually our leaned to valuation rate UM and very very very few

mortgages would be issued more than seventy. And I don't want to imply that that's not gonna be a problem for people because some people will face a big increase in their mortgage costs. We would say that they could quite afford it, but they may have to adjust to other parts of their spending in a way that they

don't want to do. I mean, I had I had a neighbor that you know, came over for a cup of coffee, former Air Force nurse, a force of nature, and she remarked, you know, she remembers when interest rates were like a twelve. Well, if you know, if the if the bank raises rates very sharply over a consenting period of time, clearly the stress that we would impose would be larger, and the consequences would be that the

mortgage availability would reduce. I mean, for any individual, you know, you would be ending less than you would have done before. And that's abound to have an effect on the on the house price market. But is that a real possibility or at some point the market implied also that the interest rates would come down and this has huge application

for more regin people spending well. I think the central forecasts that we would look at at the moment would be that you know, you will see a peak of rates and quite sure precisely how high it will be, but that eventually, you know, the energy prices will fall out of the calculation, because unless energy prices going on and on and on, the big spike will gradually fall out of the inflation rate. So I don't see at

the moment anybody forecasting double digits interest rates. But I mean, it's it's logically true that if they did, then we would be stress testing at a higher level. That I don't see that at the moment. So what Okay, so rates go to five six pc or so, maybe peek at some point around there, But what is the impact then? You you mentioned the spending. Yes, maybe there's not so many defaults because people can cope with their mortgages, but they knock on effect the economy. I mean, what sort

of recession are we about to side the world? I mean, you know, I've been taking the view that we must be careful to talk ourselves into a super gloomy posture because consumer spending has been holding up to be confidence has fallen, but there's still a lot of discretionary spending

going on. And the big impact for us looking at the past on default rates and real distress has been unemployment and it's when unemployment rises that you get these particular problems because people do assume and you need we assume that you you've still got your income. And so I think the biggestsue is whether this recession does deliver a significant increase in unemployment. Not much sign of that at the moment. So people are are dropping off the

labor for us, well, that's true. They will of course find it more difficult to get mortgages and if they need to in the future, because you know, once they've lost their their main source of income and the long term sick is extremely worrying for the overall economy point of view. So it depends. If you're asking me just about the overall economy, I would say yes, yes, yes,

it looks a bit gloomy. If you're asking me about specifically about the bank, our customers, financial distress, financial stability at the moment, you know, businesses tend to be tending to repay. We don't have we don't have huge provisions for for bad debts. We don't seem to need that at the moment. There's still, of course, quite a lot of government guaranteed borrowing out there because of COVID so

that's one reason why it is. But at the moment, the banks, I would say, and I don't think market leg markets still tight. As COVID meant that households also

built in cash buffers, yes they did. I mean, you know, on average, or the average is slightly silly number, but on average, our customers had about five thousand pounds more at the end of the COVID period in deposits than they had before because their income for the most part remains remained the same and their expenditure felt now they're they're reducing that and if you go to any airport you'll see what they're doing sort of, you know, they travel expendure just going up and still still at a

very high level. So people are running down those balances, but they still we still have more deposits than we would usually have at this stage of the cycle. Can I ask you about small businesses that West does a huge amount in terms of entrepreneurs in this country, and you know, the Prime Minister and the chance to talk about growth, growth, growth, The whole mantra of this government is around encouraging growth. What are small businesses doing in

this environment? Are is this? Is this a country now that people want to start businesses where entrepreneurs want to build for the future, or is this environment or this uncertainty in high interest rates, is that really putting them off. I think it's bound to have an impact, but it's not catastrophic at this point. You know, we have some targets for the number of new businesses which we want

to lend to. We did have to suspend that in COVID because the new new business formation fell during the COVID period, but it's picked back up again, so it's not bad. But if you ask me, do high interest rates and a recession have an impact, well, of course they do. What do you think about this characterization of anyone who disagrees with the Chancellor as being the anti growth coalition? Yeah? Well I've been trying to join, but I can't find the website at the moment, but I'm

sure there will be one barely soon. You'll get an invitation after this podcast. I mean, this is you know, the politics, and you know, I'm not sure how much wisdom I can add to that, because you know, I think it mixes up quite a lot of different tendencies. I mean, there are clearly obstacles to growth in the planning system and all of that. And you know we we would benefit as a bank if some of those were eased because there'd been more lending opportunities for us

and all of that. But you know, the rhetoric is politics and that sort of broader sort of financial rules. And you say as about I mean, there's a there's a big effort to try to deregulate and maybe you know, sitting where we are in the City of London trying to give the city a boost, do you think this government's instincts are right on that? And are you in conversations at all with the city minister, with the Chancellor about how we can make the city you know yet

again the financial couple of Europe or increase that position. Yes, the answer is yes on that specific question. Are the discussions going on the government plans are a package sort of big bang two point zero as they tend to call it. And you know, people are being asked, not just us, but a lot of other people about asked for their ideas. And undoubtedly there are some ideas around, I mean, the most obvious being a reform of solvency too, though the Bank of England, you know, will have to

be brought along with that. That's the rights, that's the right approach. Well, I think solvncy too, Yes, because I do think that Solvency two has had some unintended consequences in making it harder for the long term investments for a long term life insurance companies and pension funds to invest in long term infrastructure projects. I would say, incidentally that it's under reform in the EU as well, because this argument is is accepted. The question is just how

far you go the matching adjustment? How far you know you are prepared to allow people to engage to invest in very long term projects which perhaps don't produce a return for a short foin for quite a few years, but eventually might So there's some technically issues there, but yes,

I think I think that's worth doing myself. Then there are other things like well, we we would argue that ring fencing is a redundant imposition on on banks and it's quite costly for people like us, And the government has produced a report which they still haven't implemented on making some improvements to that regime. And that's another area which I think something could be could be done in.

But what about banker bonuses does it attract I mean unclear whether they'll go ahead with this the regulation, but does it really attract talents? I remember you saying years ago that there was a top percentage of you know, top bank earners in London, but because of Briggs and the clearinghouses, that was that danger of going to Europe. Yes, I mean it's um, I think from about the bankers bonus thing, isn't It's not something that I was aware

anyone was particularly lobbying for it. Certainly it's never come up in the beatings of the chairs of British banks UM, and particularly that you know, the timing is is interesting because of the squeeze on reeling comes elsewhere. I suppose the logic for that change is that if you are, particularly say an American bank, UM, wanting to move somebody high, very high earner from the US into Europe, then in if the banker's bonus control goes off in London, it

would be a more attractive place to move them. I don't think it would make a great deal of difference to us or indeed most of the British banks. Actually now you know whether that's whether that's worth it, whether it will have a big enough impact to be worth the cost, and the sort of reputational issues is a moot point. Sir Howard, thanks so much for joining us. Thank you brilliant, thanks for listening to this week's in

the City. We will be back next week, but in the meantime, if you like our show, please head on over to Apple Podcasts or wherever you listen to podcasts and rate, review and subscribe, and also don't forget to sign up for our newsletter, The read Out with Allegra Stratton on blombo dot com slash Newsletters, or check out the show notes for a link. This episode was hosted by Me Francine Laqua and Me David Merritt. It was produced by Summer Saidi and special thanks to Sir Howard Davis, A