Liz and Rishi — leave the Old Lady alone
Don't throw away the Bank of England's independence in search of a quick fiscal fix
Twenty-five years after UK chancellor Gordon Brown first granted the Bank of England its independence, the mandate has come under fire from the Tory leadership hopefuls jostling to become the next UK prime minister.
However, as the prime ministerial wannabees propose sweeping changes to the Old Lady, they must beware upsetting the apple cart — and the financial markets — as they look for short term fixes.
Liz Truss, the bookies’ favourite to become Tory leader and thus prime minister, has repeatedly said that she would review the Bank of England’s mandate if elected. In an interview with The Telegraph, Truss said that she wants “to make sure [the Bank] is tough enough on inflation”, while asserting that she will not clamp down on its independence.
Truss is not alone in piling pressure on the Old Lady — last month, fifth placed candidate Tom Tugendhat told BBC Radio 4’s Today programme that the “sugar high” of the Bank of England’s quantitative easing has fuelled inflation.
Even Truss’ opponent Rishi Sunak has stepped on the Bank’s toes, having proposed to include a “call-in power” in the Financial Services and Markets Bill during his tenure as chancellor. Although this clause would not interfere with the Bank’s rate setting abilities, it would allow politicians to adjust financial regulation. Although the clause was not included when current chancellor Nadim Zahawi submitted the bill last month, it does point to the ex-chancellor's loyalties.
Sunak has, however, remained quiet on the topic of BoE independence during the current election contest.
In theory, an independent central bank should be free from the interest of politicians and focused on delivering monetary policy that reflects the needs of the economy, not those of elected officials.
The Bank of England is on the cusp of its biggest rates rise since 1994. The expected 50bp increase at this Thursday’s meeting could take the base rate up to 1.75%, as it looks to counter a rate of inflation that is anticipated to hit 11% later this year.
But the tax plans of the two Tory leadership hopefuls could weigh on the Bank of England’s policy decisions. Both Truss and Sunak have placed tax cuts at the heart of their campaigns, with Truss promising £30bn in quick succession and Sunak £19bn over several years.
Is now the right time to cut taxes?— BBC News (UK) (@BBCNews) July 25, 2022
Rishi Sunak says it's not "responsible" to put debt on "the country's credit card", but Liz Truss says "no other country" is raising taxes and she would begin paying down debt in "three years' time"#BBCOurNextPM https://t.co/3IYl0rAxVx pic.twitter.com/k8WfRGreL9
Sunak has repeatedly attacked Truss’ plans to fuel inflation, calling her plans irresponsible for piling extra borrowing onto the “country’s credit card” — a favourite analogy of austerity pursuing former-chancellor George Osborne.
However, the Institute for Fiscal Studies noted that the two’s plans are “increasingly similar,” adding that "some of the critiques that Mr Sunak has so far levelled at Ms Truss’ plans now also apply to his own".
Analysts at ING said that depending on the result of the Conservative leadership contest, potential tax cuts could "ultimately see the Bank deliver another 25bp-50bp on top of [the 50bp] we’ve been forecasting”.
Nick Macpherson, permanent secretary to the treasury from 2005-2016, last month called the tax cutting plans of Truss and the other candidates “less the heirs to Margaret Thatcher; more the disciples of Recep [Tayyip] Erdogan”.
Turkey’s president Erdogan has repeatedly meddled with the Central Bank of Turkey, sacking multiple governors that go against his favoured policy path. Erdogan has taken the unorthodox view that higher rates cause inflation, sending the value of the lira down in the process.
Turkey’s year-on-year inflation hit 78.62% at the end of July, but the central bank has kept its policy rate at 14% since January.
Of course, the role of Bank of England head exists outside the confines of Westminster politics, with governors enjoying long spells that recent prime ministers could only dream of. Since incumbent Andrew Bailey’s predecessor Mark Carney took over as governor partway through the first of David Cameron’s prime ministership in 2013, the UK has had three elections and has changed its leader just over once every two years. Furthermore, whoever wins the next Tory leadership election will face a general election in just under three years’ time, with the Conservative party currently trailing Labour in the polls.
One could argue that this stability — Mervyn King and Mark Carney served for 10 and seven years, respectively — allows the Bank of England and its governor to take a long-term view on policy, free from any of the short-term fixes desired by the UK’s short-term prime ministers.
A decision to rein in the Bank of England's mandate in any capacity will more than likely have a knock on effect on the wider UK financial markets and economy — perhaps not the best use of official's time during the biggest cost of living crisis in generation.
“The mere announcement of the intention to do so would in itself be so damaging to market confidence that any Government would be extremely reluctant to attempt it,” former chancellor Nigel Lawson told then prime minister Margaret Thatcher in November 1988. “And of course, the longer the independent central bank had been in place, the more effective that sanction would be.”
After 25 years of independence, the sanction might be very big indeed.