What is the Bank of England’s inflation mandate and why is it important

The Bank of England is under growing criticism from Conservative MPs who say the central bank is too slow to tackle rising inflation.

Andrew Bailey, bank manager, warned This week, consumer price inflation, which already hit a 40-year high of 9.4% in June, will top 13% by the end of the year.

Liz Truss, foreign secretary and leader in the race for Britain’s next prime minister, said in a campaign this week that she want change the central bank’s mandate to control inflation. Here the FT looks at how the Bank of England fulfills its role 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. He also supports the government’s economic policies, including its growth and employment goals.

The current UK government sets an inflation target for price stability, which is currently 2 percent 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, all three of its peers set their own inflation targets.

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

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

If inflation exceeds or falls short of the target by more than 1 percentage point, the governor of the Bank of England must write a letter to the chancellor explaining why and what actions the bank is taking to resolve the situation.

Ruth Gregory, senior UK economist at Capital Economics, said the BoE’s mandate was “at least on paper, the least tolerant” of higher inflation compared to the Fed, ECB and Bank of Japan.

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

Since Labor Chancellor Gordon Brown granted it operational independence in 1997, it is up to the Bank of England to decide what policy measures it should take to meet its inflation target.

The bank influences the rise in prices in two main ways. First, it sets the “bank rate” – the interest rate that the central bank charges other local banks for borrowing funds – and takes steps to ensure that it is passed on to households and businesses.

Second, he can use asset purchases, also known as “quantitative easing.” When a bank buys bonds, the interest rate for bondholders goes down, resulting in lower lending rates for households and businesses. This should help increase spending and keep inflation at the target level.

James Smith, director of research at the Resolution Foundation, said the approach has been “a mainstay of British economic policy for the last quarter of a century,” a period during which inflation averaged nearly exactly 2 percent.

Will the independence of the Bank of England be threatened by changes to its mandate?

Some experts argue that there is room for revision. “After 25 years, it makes sense to return to this issue. [of the mandate] and look at things that can be improved,” said Kostas Milas, professor of finance at the University of Liverpool.

In 2013, Conservative Chancellor George Osborne revised the Bank of England’s mandate to formally support the central bank’s practice of allowing inflation to exceed its target if the alternative threatens to cause an economic downturn.

Mandate changes can include a different acceptable range for the target, the introduction of money supply targeting, or an adjustment to the voting system for external members of the monetary policy committee.

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

And many have expressed concern that any call by the government to revise the mandate raises questions about the independence of the Bank of England.

To the extent that this has become a central part of the management debate, “there is concern about the degree of politicization of this issue and the potential risk to the perception of Bank of England independence,” said Paul Hollingsworth, chief European economist at BNP Paribas. .

Krishna Guha, vice chairman of investment banking advisory firm Evercore ISI, said any talk of revising the mandate could introduce “uncertainty into financial markets and the business community, that uncertainty has an economic cost and should therefore not be done lightly or unreasonably.” great attention.”

Has the Bank of England fulfilled its mandate?

With annual CPI inflation averaging nearly exactly 2 percent since the bank’s independence in 1997, “it says the Bank of England has done a good job,” said Andrew Goodwin, an economist at Oxford Economics.

Inflation is currently well above the inflation target, but this is also the case in most countries, reflecting the rise in commodity prices following Russia’s invasion of Ukraine.

With an inflation rate of 9.1 percent, the US is experiencing only marginally lower price pressures than the UK. In many eurozone countries, weakening labor markets and government support for households facing rising energy prices are holding prices back.

Rate differences aside, inflation in most advanced economies is at its highest level in decades.

Hollingsworth said hitting the 2% target, given the twin shocks of the pandemic and the war in Ukraine, would be nearly “impossible for monetary policy alone.”