What is the BoE’s mandate on inflation and why is it important

The Bank of England has come under increasing criticism from Conservative MPs who claim the central bank has been too slow to tackle rising inflation.

Andrew Bailey, the bank’s governor, warned this week that consumer price inflation, already at a 40-year high of 9.4 per cent in June, will exceed 13 per cent by the end of the year.

Liz Truss, the foreign secretary and front-runner in the race to become the UK’s next prime minister, said at one of the leadership protests this week that she wants to change the central bank’s mandate to ensure it controls inflation. Here the FT looks at how the Bank of England is doing and where it stands in relation to its peers.

What is the mandate of the Bank of England?

The Bank of England has a primary mandate to maintain price stability. It also supports the government’s economic policy, including its growth and employment goals.

Today the UK government sets an inflation target for price stability, which is currently at 2 per cent based on the Consumer Price Index. This goal is the same for most central banks in advanced economies, including the US Federal Reserve, the European Central Bank and the Bank of Japan. Unlike the Bank of England, its three peers have set their own inflation targets.

The Fed has a second target for maximum employment, which allows the US central bank to give more weight to developments in the labor market than the Bank of England can when setting monetary policy.

The Bank of England’s inflation target is usually confirmed by the government annually. It was last changed in December 2003 when it replaced the 2.5 per cent target based on the retail price index.

If inflation exceeds or exceeds the target by more than one percentage point, the Governor of the Bank of England is required to write a letter to the Chancellor of the Exchequer explaining why and what action the Bank is taking to resolve the situation.

Ruth Gregory, chief UK economist at Capital Economics, said the BoE mandate was “at least on paper, the least tolerant” of higher inflation than the Fed, European Central Bank and Bank of Japan.

How does the authorization relate to the bank’s ability to set interest rates?

Since it was granted operational independence by Labor Secretary Gordon Brown in 1997, the Bank of England alone decides what policy action it should take to achieve the inflation target.

The bank affects price growth in two main ways. First, it sets the “bank rate” – the interest rate the central bank charges other domestic banks to borrow money – and takes steps to ensure it is passed on to households and businesses.

Second, it can use asset purchases, also known as “quantitative easing.” When the bank buys bonds, the interest rate for bondholders goes down, which results in lower loan rates for households and businesses. This would help increase spending and keep inflation on target.

This approach has been “a mainstay of British economic policy-making over the past quarter century”, said James Smith, director of research at Resolution, a period when inflation was around 2 per cent.

Will changes to its mandate affect the independence of the Bank of England?

Some experts argue that there is room for revision. “It makes sense, after 25 years, to reconsider this case [of the mandate] “And look at the things that could improve,” said Kostas Melas, professor of finance at the University of Liverpool.

In 2013, Conservative Party chancellor George Osborne revised the BoE’s mandate to provide formal support for the central bank’s practice of allowing inflation to exceed its target if the alternative threatened to trigger economic deflation.

Changes to the mandate could include a different target variance range, the introduction of money supply targeting or modifications to the voting system for external members of the MPC.

However, some economists point out that in most other advanced economies, rather than looking to change the mandate, most central banks are reviewing their strategies to ensure they can fully comply with it.

Many have expressed concern that any call for a review of the mandate by the government raises questions about the independence of the BoE.

To the extent this has become an essential part of the leadership debate, Paul Hollingsworth, chief European economist at BNP Paribas, said, “There is concern about the degree of politicization of this issue and the potential risks to perceptions of BoE independence.” .

Any talk of the mandate review risks injecting “uncertainty into the financial markets and business community,” said Krishna Guha, vice president of investment banking advisory firm Evercore ISI. This uncertainty has economic costs, and so it should not be done easily or without much care.”

Has the Bank of England fulfilled its mandate?

Andrew Goodwin, economist at Oxford Economics, said annual CPI inflation averaging exactly 2 per cent since the Bank’s independence in 1997 “indicates that the Bank of England has done a good job”.

Inflation is now well above the inflation target, but this is also the case in most countries, reflecting the rise in commodity prices after the Russian invasion of Ukraine.

With an inflation rate of 9.1 per cent, price pressure in the US is only marginally lower than in the UK. In many Eurozone economies, sluggish labor markets and government support for households facing rising energy prices have kept price growth low.

Beyond the differences in rates, inflation is at multi-decade highs in most advanced economies.

Achieving the 2 per cent target given the double shock of the coronavirus pandemic and the war in Ukraine has been nearly impossible for monetary policy alone, Hollingsworth said.

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