Bank of England fights to save its reputation - and the economy

Less than a year ago the Bank of England and Treasury were being accused of working together too closely – “hand in glove”, as one MP put it.

Digital money printing from the Bank neatly matched the Government’s borrowing and spending spree through the pandemic, raising eyebrows over the possibility of coordinated policy between ministers and the supposedly independent rate-setters.

That era of harmony now looks to be over.

At the weekend, Cabinet ministers hurled a volley of grenades at the Monetary Policy Committee.

“It has one job to do – to keep inflation at around 2pc – and it’s hard to remember the last time it achieved its target,” said one.

Inflation was bang on the 2pc target last June but it's been a wild ride since. Prices are thought to be up by more than 9pc on the year, with inflation set to hit 10pc in the autumn, the highest since the early 1980s.

Another top minister said Boris Johnson’s administration is “now questioning [the Bank's] independence”, potentially undoing Gordon Brown's move in 1997 to let the Monetary Policy Committee set interest rates without interference from Number 11 Downing Street.

Andrew Bailey responded enigmatically.

“I don’t live in the world of anybody’s politics, it is not a world I particularly respond to at all,” he told the Treasury Select Committee.

But he admitted he is “always concerned about ensuring the Bank’s independence is preserved”, calling the current situation “the biggest test of the monetary policy framework in its 25 years.”

Independence and the inflation target “matter more than ever - more than in the easy times,” he said.

Tories target Bank

Why the sudden hostility from the Tories? After all, they chose the Governor and the rest of the MPC, who are political appointees, even if they have independence when it comes to day-to-day decisions.

The answer is the political pressure facing the Conservatives right now.

Anger at the cost of living crisis is intense – YouGov surveys indicate voters are almost twice as likely to back Sir Keir Starmer’s Labour than the Tories when it comes to managing the issue – but the Government’s record on helping ease the crisis is mixed, to put it charitably.

Loans to reduce bills and a modest cut to fuel duty have been matched with raids on workers in the form of higher national insurance tax contributions, hitting incomes.

Economists see more than a little buck-passing in the barrage directed at the Bank of England.

“It smacks of politicking at a time when the Government is behind in the polls and has an economic crisis to deal with,” says Kallum Pickering, economist at Berenberg Bank.

“I don’t remember any of these politicians criticising the Bank of England for buying lots of bonds and cutting interest rates during the crisis which allowed the Government to very aggressively support the economy.”

The MPC has made its excuses. Most of the pressure on prices is effectively imported from overseas, officials say, and could not be stopped by the Bank regardless of what it had done with interest rates.

“The Bank could not have prevented the war, it could not have prevented China from pursuing the zero Covid policy, it could not have prevented President Biden from handing out excessively large stimulus cheques - those are the reasons why we have so much inflation, not the Bank pursuing QE for an extra four to five months,” says Pickering.

But price rises were already set to be extraordinary before Russian tanks rolled into Ukraine.

That was the warning from the Bank's then-chief economist, Andy Haldane, a year ago. Haldane, who served on the MPC until the middle of 2021, was a lone voice last summer when he called for quantitative easing to be brought to an end, fearing inflation would soon pick up.

Spectre of the 1970s

Now there are signs of new inflationary dangers emerging, will the MPC be more proactive?

Mel Stride, chairman of the Treasury Committee, has complained that domestic inflationary pressures, led by a tight jobs market and rising wages, potentially risking a dreaded wage-price spiral, seem to have been overlooked or obscured by the international issues.

Confidence in the Old Lady of Threadneedle Street may already be at risk, given the echoes of previous inflation shocks. The MPC will be keen not to repeat the mistakes of the past.

“There's this historical ghost of the 1970s, which I think is even more powerful than the politics that is moving against them,” says Dario Perkins, head of global macro research at TS Lombard.

Bailey had been keen to dismiss such comparisons as recently as November. “We’re a long, long way from the 1970s,” he told MPs then. By March, his confidence had diminished, warning the energy price shock would be greater than any single year during the oil crisis.

Speaking at an event last month, he said it had become increasingly difficult to call inflation “transitory”, warning the phrase – beloved of central bankers as prices first began to climb last summer and autumn after lockdowns – had become a term of “disrespect” as households struggled.

“There was a very good reason why it was regarded as transitory at the time,” Bailey said. “There were reasons to believe that it would end and that we would go back to a degree of normality.”

The MPC has been forced, repeatedly, to change its mind, and was dogged by allegations of groupthink in the run-up to its 25th birthday earlier this year.

As its members adjust to the shifting economic landscape, it has left markets with whiplash. Investors were stunned after the MPC’s November meeting, when an interest rate increase that looked bolted-on failed to materialise. The MPC then pulled the reverse trick at its December meeting, bringing in an increase that many thought had been put on ice by omicron.

These episodes have exposed chinks in the Bank’s armour – ones the Tories appear keen to exploit as they try to shift the blame for soaring costs.

Over the past year Rishi Sunak has turned from a high-spending Santa Claus – stoking inflation himself by paying people to stay away from work – to a tax-hiking Grinch with little desire to commit to more help. He would no doubt be happy to keep the spotlight on the Bank of England.

Now, the pressure is on Threadneedle Street to rescue its reputation – and the economy with it.

“It isn't just that politicians are pointing fingers at them,” says Perkins.

“It's that they don't want to be remembered in history as the guys that screwed this up.”