MNI INTERVIEW: New Fiscal Rules Ease Political Pressure On BOE

The exclusion of Bank of England operations from new UK public-sector borrowing rules should give the Treasury more control over meeting its targets and ease political pressure on BOE policy making, an analyst at influential think-tank the Institute for Fiscal Studies told MNI.

From the Treasury's perspective removing the BOE from its fiscal goals will initially make it harder to show public finances are on track, as the vast Term Funding Scheme disappears from the arithmetic. But as the BOE tightens policy and unwinds its GBP895 billion of quantitative easing the Treasury will avoid potential, and hard to estimate, hits, said Isabel Stockton, economist at the IFS, welcoming the change.

Any doubts over the future of the Bank's independence should also be assuaged by the new fiscal rules, said Stockton. Lawmakers on the Lords Economic Affairs Committee recently raised concerns about political pressure on the BOE due to the effect of its schemes on the public finances, particularly in the wake of pandemic-era bond buying.

"I am not saying anyone is actively trying to stifle that independence but circumstances have put pressure on it. So it seems reasonable to welcome additional distance," Stockton said.

The new fiscal rule unveiled in last month's Budget by Chancellor Rishi Sunak aims at a fall in public sector net debt as a share of GDP, excluding the BOE, three years ahead. While the Office for Budget Responsibility foresees a 10.2-percentage-point fall in the debt-to-GDP ratio by 2026-27 from its peak in the 2021-22 fiscal year, some 8.4 percentage points of this reduction comes from the Bank, primarily as a result of winding down TFS cheap commercial bank funding operations.

POLITICAL CHALLENGES PERSIST

"If – as seems sensible – you take the view that it is a good idea to constrain the Chancellor in terms of spending and taxes then I think it is, to say the least, questionable whether we want fiscal rules that take gains and losses on the Term Funding Scheme or on other Bank of England operations," Stockton said. "We don't set fiscal rules to try and constrain the decisions of the Bank of England. They are to help Chancellors make good fiscal policy decisions.

Premia valuation effects on the BOE's GBP875 billion gilt portfolio held in its Asset Purchase Facility alone are forecast to reduce net debt by GBP7.9 billion year-on-year in 2024-25 and by GBP2.0 billion in 2026-27, according to the OBR, though these numbers could shift sharply and would be a wildcard for the Treasury.

Under its new tightening framework the Bank will allow gilts to mature without replacing them once Bank Rate, currently at 0.1%, hits 0.5% and then decide whether to sell bonds at 1.0%. The new fiscal rules mean that the Chancellor will not come under pressure to make up for any resulting losses.

"If there are losses on selling gilts acquired through quantitative easing, do we really think that that should prompt the Chancellor to raise taxes?" noted Stockton.

Political challenges relating to the Bank's role are unlikely to entirely evaporate, however. Given limited public awareness of fiscal rules, changes to them are unlikely to end the perception that BOE operations are drivers of fiscal policy changes.

And increases in Bank Rate, used to renumerate banks which have sold gilts to the BOE under QE, will still automatically feed through to higher public debt servicing costs. A high interest rate scenario, prompted by persistent inflation overshoots, could push up debt interest costs by about GBP30 billion a year over the next couple of years, according to the OBR.