Business

Budget 2013: Bank of England gets new orders

Bank of England
Image caption Incoming governor Mark Carney has signalled intentions to raise the Bank's firepower to boost the economy

The Bank of England has been ordered to consider using unconventional monetary tools to boost the economy, as growth forecasts were cut again.

George Osborne announced the revision to the Bank's remit as he delivered the country's annual Budget to Parliament.

Growth is expected to be just 0.6% this year, putting fresh pressure on the Bank to do more for the economy.

In a key change, the Bank may now provide explicit guidance on how long it will keep its monetary policy loose.

Forward guidance

The forward guidance will be much like the one currently used by the US Federal Reserve as an unorthodox policy stimulus.

This assumes that providing an indication about how long interest rates will remain low will weigh on longer-term interest rates and thereby lower borrowing costs for households and businesses, and help improve broader economic conditions.

"It is the central plank of our economic plan that a tough and credible fiscal policy creates the space for an active monetary policy," he said.

"Recovering from the financial crisis has exposed the shortcomings of conventional monetary tools. We in Britain have had to innovate and develop new tools. So have other countries.

"The new remit also recognises that the Monetary Policy Committee may need to use unconventional monetary instruments to support the economy while keeping inflation stable," he said, while calling for greater communication and transparency between the Bank and the Treasury.

Mr Osborne also said that the Bank's current £375bn asset purchase programme - also known as quantitative easing - would remain in place, a well as the Funding for Lending Scheme to raise lending for businesses.

The Bank should also maintain its inflation target at 2%, despite recent speculation that the spot target would be changed to a range.

More help

Governor Sir Mervyn King and his successor Mark Carney have agreed to the remit, he added.

The new orders to the Bank, the first in a decade, came amid fears that the economy has tipped into its third recession since the financial crisis began.

The government, committed to fiscal austerity, wants the Bank to do more to help the economy grow, instead of just focusing on inflation.

It hopes that the arrival of Mark Carney as the Bank's new governor in July will breathe new life into the economy.

Mr Carney, currently the governor of the Canadian central bank, who will succeed Sir Mervyn in July, is understood to want to take a wider view of managing the economy.

The Bank of England's core priorities have been to stabilise prices and to prevent threats to the financial system.

Current mandate

The central bank's current interpretation of its mandate is to get the annual inflation rate down to 2% within two to three years. For the past five years, the inflation rate has been above that level.

In February, the main consumer price inflation index hit 2.8%, pushed by higher tuition fees and domestic energy bills.

The Bank has so far allowed the rate to overshoot the target, with expectations that inflation will remain well above the 2% target for the next two years, to avoid harming the economy.

Mr Carney indicated earlier this year at the World Economic Forum in Davos that economies needed to pursue policies in order to "achieve escape velocity" and that there was still room for monetary stimulus.

But Sir Mervyn has previously said that the government should not rely solely on monetary policy to nurse the economy back to health, and that more should be done on the supply side to help improve the UK's ability to produce goods and services.

The Bank has already kept benchmark interest rates at a historic low of 0.5% since 2009 and maintained the size of its asset purchase programme at £375bn, aimed at injecting money into the financial system and spurring bank lending.

In spite of this, the economy has remained weak, with the the Office for Budget Responsibility now halving its previous 2013 growth forecast of 1.2%. It also revised down 2014 growth from 2% to 1.8%.

The UK economy shrank by 0.3% in the last quarter of 2012, with fears of another contraction in the first quarter of 2013.

That would put the UK back into a recession - technically defined as two consecutive quarters of economic contraction - for the third time in about four years.

Market reaction

Markets were muted over the Bank's new mandate.

"The change to the remit doesn't go quite as far as some in markets had speculated, and therefore the reaction from the currency and gilts has reflected this," said Philip Shaw, chief economist at Investec.

"It does, however, potentially give the Monetary Policy Committee more flexibility to ease monetary policy further," he added.

But Brian Hilliard, chief UK economist at Societe Generale, said that the government's new instructions for the Bank could potentially damage its reputation.

"Where I do think criticism is in order is the idea of discussing forward interest rate guidance with the Bank of England. This is monetary policy - it's not government's role to interfere in that. So I think that is something that slightly damages the Bank of England's independence."