February 28, 2013 / 11:06 AM / in 5 years

BOE FOCUS-Britain's Old Lady shows appetite for new thinking

* Negative interest rates and new credit scheme on radar

* Openness on alternatives contrasts with prior approach

* BoE keen to look innovative in face of weak growth, Carney

By David Milliken

LONDON, Feb 28 (Reuters) - There has been a sudden flowering of new ideas at the Bank of England, with everything from negative interest rates to a long-term commitment to bond-buying said to be up for discussion.

Could it be that a new boss is coming? Or simply that things in Britain’s economy are getting decidedly worse?

Just a couple of weeks ago, most economists did not expect policy at the bank, nicknamed the Old Lady of Threadneedle Street, to change this year - or at least not before Bank of Canada Governor Mark Carney arrives in July to take over.

Outgoing Governor Mervyn King had cast doubt on the ability of monetary policy to do much to revive Britain’s stagnant economy, and stubborn inflation appeared to have left officials in a quandary over pumping in more new money.

But last week, the bank’s policy minutes unexpectedly showed that King and markets expert Paul Fisher had joined stalwart dove David Miles in a minority in favour of new asset purchases.

And just as significantly, policymakers have since said they considered a range of other options to boost demand, ranging from charging banks to deposit money at the central bank to a scheme to finance firms’ day-to-day borrowing.

It smacks of a break with what former policymaker Adam Posen described as a conservative culture which made him “furious” during his years at the bank.

“They have in the past talked about other potential options,” said Vicky Redwood, chief UK economist at Capital Economics. “But they seem to have come back to it ... partly because the economic recovery still is not getting going.”

Britain is teetering on its third recession in four years, its main euro zone trading partner is suffering, and the government is committed to more tight-spending austerity after a credit rating downgrade.

The ideas-fest also comes at a time when the U.S. Federal Reserve and the Bank of Japan have embarked on other alternative strategies, whether by giving an open-ended commitment to bond purchases or targeting higher inflation.

Currency markets have already reacted. The yen has slid against the dollar and sterling is at a two-and-a-half year low - in part because Bank of England policymakers have said they are relaxed about the temporary inflation impact of depreciation needed to bring Britain’s trade deficit closer to balance.


The bank is said to be sensitive to the perception that it is too reliant on two or three tools - interest rates, bond purchases and a relatively new scheme to boost bank lending - at a time when the economy may need more.

“They are trying to make it clear, first of all that they want to loosen policy, and second that they have a range of options available. They have not run out of tools for stimulus - which was what it sounded like for a period,” said Michael Saunders, chief UK economist at Citi.

Policymakers have been clearer than previously, for example, that they believe bond purchases with newly created money - also known as quantitative easing - can still provide benefits, although some officials think other options may be better.

And if asset purchases do restart, they could have a different tempo to before. King, Miles and Fisher all backed a 25 billion pound ($39 billion) increase - less than previous rounds which have led to 375 billion pounds of purchases so far.

But Fisher said publicly late on Tuesday that this could be just the first in a longer series, coming closer than before to the U.S. Federal Reserve’s style of ongoing purchases.


Capital’s Redwood thinks a new boss may be behind some of the new thinking.

“There has been a lot of talk about how Carney will improve things when he arrives, so they’d like to be seen to be doing those things already,” she said.

British lawmakers were much impressed when Carney - who has a reputation for having steered Canada clear of the worst of the financial crisis - appeared before them earlier this month.

At the Bank of Canada he has championed explicit interest rate guidance - letting markets clearly know what to expect - something the Bank of England has avoided.

He also flirted with modish ideas such as targeting not just inflation as the Bank of England does, but a mix of economic output and inflation known as nominal gross domestic product.

Carney steered clear of specifics when he spoke to British lawmakers. But this week Deputy Governor Paul Tucker - whom Carney beat to the top job - told the same parliamentary committee of two unusual policies the BoE had considered - negative interest rates and creating a tradeable instrument that banks could use to finance firms’ working capital.

There is no guarantee that either policy will see the light of day.

The prospect of negative interest rates, effectively charging banks to hold their money - and what they might mean for hard-pressed savers - was splashed over the business sections of several British newspapers on Wednesday. The BoE’s other deputy governor, Charlie Bean, subsequently played down the idea, describing it as “blue sky thinking”.

February’s policy minutes said this and other policy options such as buying assets other than gilts had been considered and found wanting - as has happened several times before.

However, this time might be different, in part because of the confidence given to the bank by the successful launch of its Funding for Lending Scheme in August 2012.

Under the scheme, the BoE gives cheap funding to banks as long as they increase mortgage and business lending. While it is too early to see if the scheme will have its full desired effect, it has already lowered banks’ borrowing costs and eased credit conditions for some firms and home-buyers.

But new ideas are likely to keep flowing, if only because the economy needs something and the bank is reluctant to cut benchmark interest rates below their record-low 0.5 percent lest they disrupt the finances of mutually-owned building societies, which need customer deposits to fund lending.

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