BoE's Bailey defends central bank flexibility, warns of bond market pressures
- Andrew Bailey says central banks have some flexibility over how quickly they bring inflation back to target.
- The UK central bank governor warns about the risks associated with overly restrictive forward guidance.
- High public debt levels pose a major challenge for governments and add to pressures in bond markets.
Bank of England (BoE) Governor Andrew Bailey said on Friday that monetary policymakers have some discretion over how quickly they bring inflation back to target, while stressing that returning inflation to the target remains imperative.
Bailey also addressed central bank communication, saying that Federal Reserve (Fed) Chair Kevin Warsh is right to identify some dangers associated with forward guidance. The BoE Governor argued that central bankers should avoid providing unconditional guidance on the future path of monetary policy.
His comments highlight the importance of central banks preserving flexibility in response to changing economic and inflation conditions, rather than committing in advance to a predetermined monetary policy path.
On the fiscal front, Bailey also stressed that high debt levels reflect the very substantial challenges facing governments. He added that elevated debt is also contributing to pressure in bond markets.
Market reaction
The British Pound (GBP) showed little reaction to Bailey’s comments. GBP/USD trades around 1.3525 at the time of writing on Friday, virtually unchanged on the day.
BoE FAQs
The Bank of England (BoE) decides monetary policy for the United Kingdom. Its primary goal is to achieve ‘price stability’, or a steady inflation rate of 2%. Its tool for achieving this is via the adjustment of base lending rates. The BoE sets the rate at which it lends to commercial banks and banks lend to each other, determining the level of interest rates in the economy overall. This also impacts the value of the Pound Sterling (GBP).
When inflation is above the Bank of England’s target it responds by raising interest rates, making it more expensive for people and businesses to access credit. This is positive for the Pound Sterling because higher interest rates make the UK a more attractive place for global investors to park their money. When inflation falls below target, it is a sign economic growth is slowing, and the BoE will consider lowering interest rates to cheapen credit in the hope businesses will borrow to invest in growth-generating projects – a negative for the Pound Sterling.
In extreme situations, the Bank of England can enact a policy called Quantitative Easing (QE). QE is the process by which the BoE substantially increases the flow of credit in a stuck financial system. QE is a last resort policy when lowering interest rates will not achieve the necessary result. The process of QE involves the BoE printing money to buy assets – usually government or AAA-rated corporate bonds – from banks and other financial institutions. QE usually results in a weaker Pound Sterling.
Quantitative tightening (QT) is the reverse of QE, enacted when the economy is strengthening and inflation starts rising. Whilst in QE the Bank of England (BoE) purchases government and corporate bonds from financial institutions to encourage them to lend; in QT, the BoE stops buying more bonds, and stops reinvesting the principal maturing on the bonds it already holds. It is usually positive for the Pound Sterling.
