United Kingdom[£]

Institutional framework

The 1998 Bank of England Act states that, in relation to monetary policy, the Bank of England's objectives shall be "to maintain price stability, and subject to that, to support the economic policy of Her Majesty's Government, including its objectives for growth and employment." The Government is required to specify its definition of price stability and its economic policy objectives at least once every 12 months. The current definition of price stability is an inflation target of 2% as measured by the 12-month increase in the Consumer Prices Index (CPI). The government's current economic policy objective is for 'strong, sustainable and balanced growth.'

Within the Bank of England, the Monetary Policy Committee (MPC) has responsibility for formulating monetary policy in order to meet the Bank of England's objectives. The MPC meets at least 8 times per year. Decisions are taken by a vote by the members present at the meeting. A statement and minutes are published as soon as reasonably practicable after each meeting. The Bank of England is then responsible for using its monetary policy implementation framework (described in detail on its website) to implement the decisions of the MPC.

Key features of the monetary policy implementation framework

The Bank of England's monetary policy implementation framework provides the MPC with a number of tools which it can use in order to meet its objectives, including: setting Bank Rate; undertaking asset purchases; supplying central bank reserves; and providing forward guidance on the future expected path of monetary policy.

Monetary policy is primarily implemented through the setting of Bank Rate, which is the interest rate paid on reserves accounts held at the Bank by eligible firms. The Bank currently implements the MPC's decisions on Bank Rate using a 'floor system', in which almost all reserves held with the Bank are remunerated at Bank Rate. This floor system was introduced in 2009, when the MPC decided to start making large-scale asset purchases. This system keeps wholesale market interest rates close to Bank Rate, because if wholesale rates fell significantly below this level, then eligible firms could borrow reserves in the market and earn Bank Rate by depositing them at the Bank of England. A key merit of this 'floor' system is its ability to keep overnight interest rates close to Bank Rate in the event of large changes in the supply of, or demand for, reserves.

Another feature of the framework is that the Bank need not set reserve requirements. This is in contrast to the Bank's pre-2009 regime, where reserve targets were set by SMF participants themselves. This framework and the various operations used to supply and drain participants' reserves were largely ceased in 2009.

Very short term liquidity needs are met through the Bank's Operational Standing Facilities (OSFs), which allow participating firms to borrow reserves directly from the Bank throughout each business day. The lending facility consists of an overnight lending transaction collateralised against high-quality, highly-liquid assets, for which participants are required to pay a 25 basis point premium (0.25%) above Bank Rate.

Unconventional monetary policy measures

In response to the 2008 financial crisis the MPC began a large-scale purchase of financial assets which, at the time, consisted mostly of UK government bonds. 1 These asset purchases were carried out by a Government-indemnified subsidiary of the Bank - The Bank of England Asset Purchase Facility Fund Limited (BEAPFF). As of end August 2019, asset purchases of UK government bonds totalled GBP 435 bn.

In August 2016 - the most recent point at which the MPC changed its policy decision on the size of asset purchases - a GBP 10 bn corporate bond purchase scheme (CBPS) was launched. The scheme aimed to provide stimulus by lowering the yields on corporate bonds to reduce the cost of borrowing for companies; encourage asset sellers to rebalance portfolios; and encourage companies to issue more bonds.

The MPC also introduced a Term Funding Scheme (TFS) in August 2016. The TFS was designed to address a risk that cuts in Bank Rate to a level approaching the zero lower bound might have less impact than cuts made when rates were higher, if lenders chose not to pass on the rate cut to households and businesses in order to protect their margins. It was calibrated such that any reduction in Bank Rate had a broadly neutral impact on margins in aggregate. The TFS provided four-year funding for banks and building societies at interest rates close to Bank Rate against a wide range of collateral. Borrowing allowances were calculated based on a proportion of firms' stocks of eligible lending, as well as increases in firm's net lending over an 18 month reference period. The scheme closed to new lending in February 2018, as envisaged when it was introduced, having made GBP 127 billion of loans.

Asset purchases under QE have meant that, over recent years, the Bank's balance sheet has become much larger than at any other time in recent history. Looking to the future, the balance sheet is likely to reduce in size again over time. The MPC will decide when to scale back asset purchases and consideration of this and other related issues is routinely published in MPC minutes.2 In 2018 the Bank began a process of engagement with the market to understand the implications of changes in its balance sheet moving forward.3

Liquidity insurance and other operations

The Bank also offers a number of liquidity insurance operations which can supply central bank reserves. The operations include: Indexed Long Term Repos, which are typically monthly (but currently weekly) market-wide liquidity operations which provide central bank reserves for a 6-month term via a competitive auction process; the Contingent Term Repo Facility, which allows the Bank to provide liquidity against the full range of eligible collateral at any time, term, and price it chooses; and the Discount Window Facility, which is a bi-lateral, on demand facility where SMF participants can borrow highly liquid assets (gilts or, in certain circumstances, cash) in return for a wide range of collateral.

In July 2012, the Bank and HM Treasury launched a Funding for Lending Scheme (FLS) in response to an increase in bank funding costs and interest rates during the crisis in the euro area. The FLS was designed to incentivise banks and building societies to boost their real economy lending by providing them with four-year funding at below market rates, with both the price and quantity of funding provided linked to their performance in lending to the UK real economy. The FLS was a joint scheme between the MPC and Financial Policy Committee.