Monetary policy: UK - BOE

Bank of England monetary policy instruments and operating targets

Operating procedure

From 2006 the BOEs official interest rate is the Official Bank Rate. Historically, the official rate has changed names several times depending on its precise purpose. Sometimes the overall concept is referred to as BOE base rate, but this confuses with another base rate used by commercial banks.

The Official Bank Rate continues (from Mar1997) to apply to the BOE repo rate for open market operations with a group of counterparties (banks, building societies, securities firms).

Details of BOE operating procedures have changed frequently. In recent years several regimes can be distinguished:

1. Mar1997: OMO repo system

1.1 OMO: 2 daily (12:00AM and 02:30PM), fixed rate ORR, using 2-week repo or outright sale. Sometimes 3rd early round at 09:45AM.

1.2 end-of-day OMO: 03:50-03:55PM late repo facility for settlement banks, at penalty rate ORR +25bp

2. Jun1998: standing facility system

2.1 OMO: 2 daily (09:45AM (12:15PM on MPC meeting days) and 02:30PM), fixed rate ORR, using 2-week repo or outright sale;

2.2 end-of-day OMO: 03:30PM late lending facility, all counterparties, overnight repo at Official Repo Rate +100bp; 04:20PM (after market) late lending facility, settlement banks, overnight repo at Official Repo Rate +150bp.

2.3 from Jun2001 additional 03:30PM late deposit facility, all counterparties, overnight repo at Official Repo Rate -100bp.

Note: 16Mar2005 rate corridor reduced to +/-25bp.

3. May2006: reserve averaging system

OMO: weekly short-term repo, 1-week repo, (10:00AM Thursdays, 12:15PM on MPC meeting days), fixed rate OBR. Also monthly long-term repo, 3-12 month repo, Tuesdays, variable rate tender

SF: standing lending and deposit facilities: overnight repo, OBR +/-100bp

Reserve averaging: large banks agree to voluntarily set one month targets for average reserve balances. Reserve balances remunerated at OBR.

Final day of reserve maintenance period: fine-tuning OMO 10:00AM for overnight repo, reduced SF corridor +/-25bp

Allowing banks to shift reserve balances over time (averaging) is expected to stabilize market interest rates without continuous BOE market intervention.

Note: 20Oct2008 SF corridor reduced to +/-25bp.

4. Mar2009: reserve remuneration system

All of banks reserve balances remunerated at Official Bank Rate.

OMO: largely irrelevant due to quantitative easing, weekly short-term repo suspended.

SF: maintained but largely irrelevant due to reserves excess and full remuneration of total reserve balances.

Reserve averaging: suspended

The BOE operating procedure must be described as an interest rate target operating procedure. The BoE more or less fixes the Sterling Overnight Interbank Average rate (SONIA). (Note: Historically this has been the 3-month Treasury bill rate and Band-1 eligible bills 1-14 days.)

Note: Jun1998 introduction of late round lending facility. Jun2001 late round lending becomes standing facility and standing deposit facility is introduced. (Note: Technically, difference between late round OMO and standing facility is the presumed control over access, but it is unlikely that BOE would withdraw late round OMO in times of market stress.) Mar2009 all reserves remunerated at Official Bank Rate. Deposit rate irrelevant.

Bank of England monetary policy strategy

[Bean 2003 BoE QB] For the first part of the post-war period, monetary policy was assigned only a marginal role in the control of aggregate demand. In line with Keynesian precepts, fiscal policy was seen as the primary tool of macroeconomic stabilisation, while interest rates were to be set low to encourage investment, and credit controls employed to restrain consumer borrowing. If excess demand pressures showed signs of spilling over into higher inflation and a deteriorating balance of payments, then incomes—rather than monetary—policy was the chosen tool to keep those pressures in check. When they turned out to be unsuccessful, resort would be made to devaluation in order to restore competitiveness. The demise of Bretton Woods and the move to a floating exchange rate removed the balance of payments as a constraint, but in its place came an increased tendency towards higher inflation in the face of excess aggregate demand. The rise in the rate of inflation in 1974 and the failure of incomes policy to bottle up inflationary pressures in anything longer than the short term led to a growing awareness of the importance of monetary control in the management of aggregate demand.

[Lildholdt/Wetherilt, 2004 BoE wp.421] In the United Kingdom, the monetary policy framework has undergone important changes in the past three decades. [For more detail, see Fforde (1983), Coleby (1983), Goodhart (1989a), Goodhart (1989b), Minford (1993) and Nelson (200[3]). ] Between 1976 and 1985, the Bank of England conducted policy in a monetary targeting framework. In July 1976, a target for broad money supply (£M3) was introduced as a response to the 1976 exchange rate crisis. But UK authorities continued to rely on a combination of direct controls (prices, wages, credit) and fiscal policy in order to combat inflation. Direct credit controls were abolished shortly after the abolition of exchange controls in autumn 1979. In spite of frequently missing the £M3 monetary target, the UK government re-affirmed its commitment to a monetary target in the Medium Term Financial Strategy (MTFS) in March 1980. As part of this strategy, a monetary target range was set over a medium-term horizon (four years), and all other macroeconomic policies were subordinated to the achievement of this target. Goodhart (1989b) writes that ‘the terms in which the Chancellor described his adherence to the £M3 target implied an unprecedented degree of commitment’. Nonetheless, monetary policy continued to be dominated by other policy considerations (e.g. concerns with a rising exchange rate after 1979 and with domestic credit expansion in 1982-85) and official interest rates were raised sharply several times, to reach a peak of 17% in November 1979. The introduction of additional money supply targets in March 1982 further undermined the public’s confidence in the monetary authorities’ commitment to monetary targeting. The £M3 money target was officially abandoned in October 1985.

After the formal suspension of the £M3 target, and in light of the instability in foreign exchange rate markets experienced during the early 1980s, monetary policy in the United Kingdom, as elsewhere, was increasingly conducted with an eye on stabilising exchange rate movements. Between 1987 and 1988, the pound remained within a fairly narrow range against the DM. Thereafter, the United Kingdom continued to follow German monetary policy, until formally joining the Exchange Rate Mechanism (ERM) in September 1990. Nonetheless, a monetary target for narrow money (M0) remained in place until 1992. Since leaving the ERM in September 1992, UK monetary policy has been conducted in an inflation targeting framework.

[In October 1992, the government announced an explicit inflation target of 1-4 percent as measured by the RPIX. Interest rate decisions would be made by the Chancellor of the Exchequer, with consultation of the Bank of England for inflation expectations and the timing of interest rate changes. In June 1995 the Chancellor announced an inflation target of 2.5 percent or less for the RPIX. Following the May 1997 New Monetary Policy Framework and the Bank of England Act 1998, the Chancellor provides annual updates of the inflation target. In December 2003 the inflation target was changed to 2 percent for the CPI, following earlier announcement in June 2003.]

After 1992, a number of institutional reforms further improved the transparency of the UK policy process. [...] Transparency-improving reforms included the introduction of scheduled meetings to discuss policy rate changes (October 1992), the publication of the Inflation Report (February 1993), the decision to publish the minutes of the monthly interest rate meetings (April 1994) and the creation of the Monetary Policy Committee in 1997. Also since 1997, the minutes have included the MPC’s votes, together with a range of views on the policy decision. In October 1998, the minutes’ publication delay was reduced from six to two weeks.

In March 2013 Chancellor George Osborne adjusted the BoE's remit by emphasing that the BoE should tolerate higher inflation when output was low and would suffer from rate rises.

Bank of England: Legislation, decision-making, transparency

The Bank of England (BOE) was established in 1694 as a privately owned, commercial bank. The new bank was granted monopoly rights on issuing banknotes, initially in the London area and later the whole of England. With the 1946 Bank of England Act, ownership and control of the BOE were transferred to the UK Treasury. The 1946 Bank of England Act lacks any reference to the objectives of monetary policy. Historically, the UK monetary policy and exchange rate policy were simply components of the government's overall economic policy. The BOE received its policy directives from the Chancellor of the Exchequer. The BoE always had mainly an advisory role and only carried responsibility for the implementation of the government's monetary policy. The Bank of England Act 1998, amending the 1946 Act to give the BOE operational independence, came into force on 1 June 1998. The Act restated that the Bank's monetary policy objective is to deliver price stability as defined by the Government's inflation target (so the BOE does not have goal independence) and, without prejudice to that objective, to support the Government's economic policy, including its objectives for growth and employment.

Details on the strategy of monetary policy were usually communicated as part of the Chancellor’s annual Budget Speech or other major public speeches. Analysis of monetary policy and the economic environment used to be published by the BOE in its Quarterly Bulletin. From February 1993 this has shifted to the quarterly Inflation Report. The Inflation Report includes an explicit outlook (forecast) for future economic developments (real GDP growth) and inflation.

Before May 1997 interest rate decisions were taken by the Chancellor of the Exchequer. From February 1993 consultation meetings with the Governor of the Bank of England occurred monthly on a formal basis. From November 1993 the BOE had discretion over timing of interest rate changes, within the limit that a change had to be implemented by the next meeting. Furthermore, a press release would be issued explaining the reasons behind a rate change. In practice, changes happened on the day (or certainly within a few days) of the Chancellor-Governor meeting. Starting April 1994 minutes were published 2 weeks after the next meeting (i.e. 6 weeks delay) compared to 30 years delay previously.

On 6 May 1997 it was announced that the Bank of England would gain operational independence and decisions on interest rates to be made by the Monetary Policy Committee (MPC, first meeting 6 June 1997). The MPC meets monthly and interest rate decisions are announced immediately after the meeting. There is no press conference and there is no further information or discussion. Minutes of the meeting are released two weeks later.

HISTORICAL DATA, TABLES, SUPPLEMENTARY INFORMATION

Table UK Chancellor of the Exchequer and BOE Governor

BOE Unconventional Monetary Policy Actions/Programmes

QE - Asset Purchase Facility

Note: Asset Purchase Facility transactions are conducted by a special subsidiary company of the BOE (BEAPFF). Quantitative easing, or the use of the APF for monetary policy purpose, consists of buying assets outright financed by creating central bank reserves (i.e. the subsidiary borrows from the BOE). Non-monetary policy transactions, i.e. buying private sector assets, is financed by the sale of UK Treasury bills by the Debt Management Office (DMO) and depositing the proceeds (i.e. the subsidiary borrows from the Treasury).

A. Quantitative Easing Program

APF announced 19 January 2009 by the Chancellor. Decision to implement 5 March 2009 by MPC. Between March-November 2009 decisions to purchase up to GBP 200 bln by buying medium and long-maturity gilts. October 2011 expanded by GBP 75 bln to 275 bln. February 2012 expanded by GBP 50 bln to 325 bln. July 2012 increase by GBP 50 bln to 375 bln.

B. Asset Exchange Program

On behalf of U.K. Treasury, purchase of high-quality private sector assets (commercial paper and corporate bonds) financed by sale of UK Treasury bills.

Bank of England. BoE Homepage

Central bank

• BoE, The Bank of England.
  • Fact sheet prepared by the Bank of England about itself.
• BoE, Monetary Policy Committee (MPC).
  • Webpage describing MPC background, objective, organisation.

Monetary policy tactics

• Wetherhilt,A.H., Money market operations and volatility in UK money market rates. BoE Quarterly Bulletin, vol.42 (4) Winter 2002:
• BoE, The Bank of England ’s operations in the sterling money markets, BoE Quarterly Bulletin, vol. 42 (2) Summer 2002:
• BoE, Monetary policy in the United Kingdom.
  • Fact sheet prepared by the Bank of England describing the technique of monetary policy in the United Kingdom.
  • BoE, The Bank of England's operations in the sterling money markets, BoE Quarterly Bulletin, vol.37 (2) May 1997:
• BoE, Reform of the Bank of England's operations in the Sterling money markets. January 1997.
  • Paper prepared by the Bank of England describing its latest change in money market operating procedures.

Monetary policy strategy

• BoE, Framework for monetary policy.
  • Webpage.
• BoE, The Bank of England's Inflation Report.
  • The Inflation Report provides detailed economic analysis and inflation projections on which the MPC bases its decisions.
  • Benati, L., UK monetary regimes and macroeconomic stylised facts, Bank of England Working paper no.290, March 2006
  • Batini, N. and E. Nelson, The U.K.'s rocky road to stability, FRB St. Louis Working paper 2005-020A, March 2005
  • Nelson, E., UK monetary policy 1972-97: A guide using Taylor rules, in Paul Mizen (ed.) Central Banking, Monetary Theory and Practice: Essays in Honour of Charles Goodhart, Volume 1. Cheltenham, UK: Edward Elgar, 2003.
  • Bean, C. Inflation targeting: The UK experience, Bank of England Quarterly Bulletin, Winter 2003
  • Vickers, J., Inflation targeting in practice: The U.K. experience, Bank of England Quarterly Bulletin, November 1998.
  • King, M.A., Changes in UK monetary policy: Rules and discretion in practice, Journal of Monetary Economics, vol.39 ( ) 1997: 81-97.
  • Minford, P., Monetary policy in the other G7 countries: The United Kingdom,' in M.U. Fratianni and D. Salvatore (eds.) Monetary Policy in Developed Countries. Greenwood Press, 1993: 405-31.
  • Bernanke, B.S. and F.S. Mishkin, Central bank behavior and the strategy of monetary policy: Observations from six industrialized countries, in O.J. Blanchard and S. Fisher (ed.) NBER Macroeconomics Annual 1992. MIT Press, 1992: 183-228
  • Temperton, P., UK Monetary Policy: The Challenge for the 1990s. Macmillan, 1991.
  • Goodhart, C.A.E., The conduct of monetary policy, Economic Journal, vol.99 (396) June 1989: 293-346.
  • BoE, The Development and Operation of Monetary Policy 1960-1983. Bank of England, 1984.
  • Fforde, J S (1983), Setting monetary objectives, Bank of England Quarterly Bulletin, Vol. 23, No. 2, pages 200–08.
  • Coleby, A L (1983), The Bank’s operational procedures for meeting monetary objectives’, Bank of England Quarterly Bulletin, Vol. 23, No. 2, pages 209–15.

Sources: Bank of England, Base Rate Information http://www.bankofengland.co.uk/mfsd/ MPC interest rate decisions and minutes http://www.bankofengland.co.uk/monetarypolicy/decisions.htm

CSO/ONS Economic Trends, Financial Statistics.