The Bank of England is the UK’s central bank, which has a number of powers and responsibilities such as setting the Official Bank Rate and influencing the money supply through other means. This makes the Bank of England one of the most influential organisations in the British economy.
The Bank of England was created by royal charter, which provides it with a special status among ordinary limited companies. Its chief executive holds the title Governor of the Bank of England.
Current responsibilities of the Bank of England
- Acts as banker to the Government
- Sets UK monetary policy (the supply of money)
- Controls the Official Bank Rate
- Engages in asset purchases (since 2009)
- Monitors the economy and price levels
- Issues banknotes
- Works with other central banks to improve the global financial system
The Bank of England’s role as steward of UK monetary policy is its defining feature. With a simple inflation rate target of 2%, the Bank controls its policy in such as a way to attempt to nudge the UK economy as close to this target as possible.
There is no clear consensus among economists as to what the ‘ideal’ inflation rate actually is, but 2% has been adopted by several central banks.
Too little inflation (or deflation) is seen as bad because it encourages consumers to defer spending.
Too much inflation brings financial instability and practical issues such as shops needing to constant revise prices. High rates of inflation tend to be difficult to tackle because as consumers begin to ‘expect’ high inflation, they will demand high wage increases which will only further field the increase in cost for business and therefore prices.
2% is seen as a ‘Goldilocks’ interest rate because it is a positive figure, and therefore discourages deferment of purchases, but is low enough to be largely ignored by the general population.
The independence of the Bank
The choices made by the Bank’s directors have widespread effects across the globe.
It is therefore important that the public is reassured that the activities of the bank are directed by technocrats rather than politicians.
The 1998 Bank of England Act handed control over the setting of interest rates from the government to the Bank and enshrined some protections for the Banks independence.
The Bank is technically a private company. Its shares are owned by the Treasury Solicitor on behalf of the government. This allows a distinction to be made between the Bank of England and wholly government institutions such as the Treasury or the Ministry of Defence.
However, as the head of the Bank is appointed indirectly by the government, we must still acknowledge that the Bank can be influenced by the cabinet and other sources.
The Official Bank Rate
The Official Bank Rate, also known as the Bank of England base rate is set by the BoE every 90 days, following a meeting of the Monetary Policy Committee.
A change in the Officiel Interest Rate has a powerful effect on economic activity in the UK because a lot of saving and borrowing products are directly linked to the Official Rate.
For example, tracker mortgages carry a rate of interest calculated as ‘Bank of England Base Rate + X%’, such as base rate + 2.5%. Therefore if the Bank of England raised the Official Rate by 0.5%, the mortgage will now carry a 0.5% higher interest rate with almost immediate effect.
The best economics books will help you learn about how a change in interest rates can affect the economy but here are some examples:
- Lower interest rates allow companies to source finance from banks at a cheaper rate. This may make some previously unviable projects become financially viable, and therefore able to go ahead.
- Lowest interest rates may allow UK stockbrokers to offer margin accounts to investors at a lower rate of interest, encouraging higher amounts of capital to be invested in the best investments.
- Higher interest rates will mean that carrying consumer debt could become more expensive, which may dissuade a cash-poor couple from borrowing money to buy an expensive car, and instead may opt for a cheaper model that doesn’t require financing.
- Higher rates will also provide a stronger incentive for consumers to save their money rather than spend it in the shops, as the reward offered on savings accounts should generally increase.
Generally speaking, lowering interest rates will stimulate economic activity whereas increasing interest rates will
Fixed-rate loans and fixed-term savings bonds insulate consumers from the immediate impact of a rate change. However, the consumer will need to accept the new rates when browsing the market for their next product. Therefore the effect of an interest rate change can take months or years for its full impact to be felt by the economy.
The Monetary Policy Committee
The Monetary Policy Committee is a group of nine economists/bankers who sit for 3.5 days eight times per year to reassess the official bank rate.
The exact composition of the committee follows the following rules:
- The Governor of the Bank
- The three Deputy Governors
- The Bank of England’s Chief Economist
- Four external members
It is worth noting that the four external members are political appointees, which gives the government some influence in the setting of interest rates.
Crucially, the committee is balanced in such a way that if the other BoE members disagree with the external committee members, the BoE staff will win a vote.
The vote of each individual is publicly published, which means that members can be held accountable for their decisions. Minutes of the meetings are also later published. This aims to provide transparency and accountability over a powerful decision taking place behind closed doors.
The Governor of the Bank of England
This position is usually unofficially chosen by the Chancellor of the Exchequer. The Prime Minister will then advise the Queen of their choice, and by royal appointment, The Governor will be appointed for a fixed term.
The Bank also has a number of deputy governors (at the time of writing, four people hold this position).
The governor is the spokesperson for the Bank of England, and will often give addresses to industry groups, the banking sector and the wider media to explain the role of the Bank and decisions it has recently taken.
Regional money printing
Although the name suggests otherwise, the Bank of England operates over the whole of the United Kingdom and not just England.
Bank of Scotland is not an equivalent financial institution, being an ordinary retail bank, albeit one with the permission to print its own distinctive banknotes. Bank of Scotland, along with The Royal Bank of Scotland and Clydesdale Bank all have permission to print Scottish banknotes.
In Northern Ireland, Ulster Bank, Bank of Ireland and Danske Bank have the right to produce Northern Irish banknotes under similar regulations.
This permission is not as powerful as it seems. The best books about banking explain that Scottish & Northern Irish banknotes are not technically legal tender in their own right They are technically a promissory note (an IOU from the bank).
The issuing banks are legally required to hold a 1:1 reserve of UK banknotes in reserve to support each note they issue under the Scottish and Northern Ireland Banknote Regulations 2009.
Therefore in effect, the banks are merely ‘rebranding’ an existing UK banknote and cannot impact the total number of notes in circulation. This practice has no impact on the money supply, leaving the Bank of England as the only institution which can increase or decrease the total number of notes & coins.