Page last updated at 16:10 GMT, Tuesday, 30 June 2009 17:10 UK

City Diaries: 1 July

Man looking at a falling graph

This week our diarists reflect on the Governor of the Bank of England's appearance before the Treasury Select Committee.

Mervyn King called for the government to show "greater ambition" in reducing public borrowing.

These diaries are written by people who work in finance and have had a front row seat as their industry goes through the biggest changes in decades.

They give us regular insiders' updates on the mood in the City of London and the dramatic changes in the world of finance.

LAURA

"Laura" (not her real name) works for a commercial bank in London.

We know that economic growth when it happens will be delicate and easily thrown off course. We don't know what regulation or public spending will be in place after the next elections

With the increasingly bold statements being made by Mervyn King it is ever more apparent that it is not just the electorate that is waiting for a general election, it is the financial markets and authorities also.

From listening to Gordon Brown waffling on about his lack of cuts (I guess he didn't get the memo that we were massively in debt) it's not surprising that our Lady of Threadneedle Street is worried. Obviously nothing earth shattering is going to happen before May next year, indeed the government has now scrapped the spending review which would have given us a better picture of where we are headed. The net result is that we are opening ourselves up to being pushed about by outside forces such as the EU, the US and of course the IMF - reactive and not proactive.

In the last week several people have asked me what I think will happen to interest rates - and at the moment this is a giant wet finger in the wind calculation. If government spending is scaled back then this may help to reduce the likely inflationary forces which are going to come into view as soon as the recession is over. If the government keeps ploughing on with its fingers in its ears then potentially interest rates are going to be ratcheted up severely to cope with sharp upswings in inflation.

What does this matter? Well for a start how do you expect banks to work on stabilising their pricing models, maintain their returns or look at appropriate rates to keep deposits, if potentially over the next 12 months we have massive swings in the difference between the interest rate charged by the Bank of England and the Libor rate that commercial banks charge each other? Government spending has a key influence on private business if it results in the base rate rising by say 4% within 12 months. After all, that is a notable increase in your banking costs and a chunk out of your profits (assuming you have them).

The brilliant revelation that "there are known knowns, known unknowns and unknown unknowns" isn't as stupid a statement as you first think. We know that economic growth when it happens will be delicate and easily thrown off course. We don't know what regulation or public spending will be in place after the next election.

Most worryingly of all, we don't know what the regulators and the government think will be thrown at us by other nations who are more fleet of foot while we are counting the days to the general election. In sympathy with this week's weather, the air over the City is stagnating.

ANTHONY

"Anthony" (not his real name) works for an investment bank in the City.

Bank of England Governor Mervyn King
Anthony thinks the Governor's statements last week were remarkable

Last week before the Treasury Select Committee, the Bank of England governor Mervyn King, made two startling revelations which indicate a deep rift between the Bank and the Treasury.

First, he said that he could not be held accountable for future financial stability if he was not given more powers, and said that the government had not consulted him on the planned regulatory changes. Next, he called the government deficit "extraordinary". He went onto say: "if the economy were to recover along the path assumed in the budget projections of GDP then I think the time over which deficits need to be reduced is likely to be faster than was implied by that projection."

His statements are remarkable because it is extremely unusual for the Bank to be openly critical of the government and I think that reflects the governor's disquiet about being kept out of the loop on regulatory change.

The sidelining of the central bank in the regulatory debate is the opposite of that proposed by President Obama where the US Federal reserve is to be given more power not less. In the US, broker dealers like Lehmans were traditionally terrified of the Fed and much preferred the more hands off approach of the Securities and Exchange Commission. This fear was born out of respect and in the City; it is the Bank which is much more respected than the FSA.

The Governor was right to be worried because a speech by Peter Mandelson has confirmed that the powers will remain with the FSA. He does not want a "twin peaks" regulatory system. The government is therefore going to neutralise the authority of the Bank of England .

The Conservatives, however, want to return power to the Bank of England by giving it responsibility for the major banks. So there is a real sense that this whole issue has become a political football but not one that will impress the voters.

Unfortunately, it won't impress the City either. Respect is one thing but changing the whole regulatory structure by passing some responsibilities back to the Bank will just delay the regulatory reform needed.

The City is more concerned that the people who sit behind the desk of the regulator are experienced practitioners rather than whether they are based at Canary Wharf or in Threadneedle Street.

The lack of respect of the FSA is based on the poor quality of supervisors. I have attended meetings with the FSA where our Chief Financial Officer with thirty years experience was supposed to have an intelligent conversation with a graduate supervisor just out of university who knew absolutely nothing about Structured Products.

The FSA have to raise their game and I think they know this.


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