The Bank of England is the UK’s central bank. It sets interest rates, creates money, and keeps the financial system stable.
The Bank’s job is to maintain monetary and financial stability in the UK. You cannot open a personal bank account with the Bank of England, instead it only provides services to the government, other banks, and central banks in other countries.
What the Bank of England does
Setting interest rates
The Bank sets the official interest rate for the UK, called Bank Rate. This directly affects the interest rates on savings accounts, loans and mortgages.
The Monetary Policy Committee makes these decisions with a primary aim of price stability, defined by the Government’s inflation target of 2% per year. The committee meets eight times a year and each member has one vote.
When the Bank cuts rates, borrowing becomes cheaper, and savings pay less in interest. This encourages spending leading to more activity in the economy.
The opposite happens when the Bank raises rates. Borrowing is more expensive, and savings pay more in interest. This cools the economy leading to lower prices, which is why it’s used to combat inflation.
Creating money and quantitative easing
The Bank can create money digitally in the form of central bank reserves. It uses these reserves to buy bonds, which is called quantitative easing or QE.
QE lowers long-term borrowing costs to support spending in the economy and hit the inflation target. The Bank created £875 billion of new money through QE in the thirteen years following the 2008 financial crash.
Printing money
The Bank of England also prints physical money which is mostly used to replace old banknotes. These are sold directly to wholesale distributors who supply commercial banks.
Even though most transactions are now paid for with debit and credit cards, physical money is still very important. Every year more money is added to circulation to keep up with demand.
Other responsibilities
The Bank regulates major banks, building societies, credit unions, insurers and investment firms via its Prudential Regulation Authority.
The Bank also runs core systems that allow people, businesses and banks to make large transfers.
Why the Bank of England exists
Created to fund war
The Bank was founded in 1694 to act as banker to the government and fund the war effort against France. King William III was desperately trying to raise funds for wars against France but existing lenders refused to help.
William Paterson, a Scottish merchant, suggested that members of the public could lend £1.2 million to the Government. The £1.2 million target was raised in just 11 days by 1,268 members of the public from all walks of life.
People who signed up became shareholders in a new company called ‘The Governor and the Company of the Bank of England’. The government paid them 8% interest.
From private to public ownership
The Bank was privately owned by shareholders from its foundation in 1694 until it was nationalised in 1946 by PM Clement Attlee.
The government nationalised the Bank because of its central importance to the UK’s economy.
Political independence and why it matters
Independence since 1998
On June 1 1998, the Bank gained operational independence to set monetary policy. Before this, final responsibility for setting interest rates lay with the Chancellor of the Exchequer.
Why independence matters
A growing body of research suggested that a rules-based policy pursued by a central bank with no other direct objectives, such as the need to get re-elected, would ensure more focus on price stability and would be credible in the eyes of firms and the public.
Politicians might manipulate monetary policy to boost their pre-election popularity, prioritising short-term political gains that could invite long-term economic pain in the form of higher inflation.
Independence has reduced the scope for short-term political considerations to enter into the determination of interest rates. The UK’s annual rate of inflation has averaged 2% from 1998 to the present.
How the Bank of England is funded
Self-funding through operations
The Bank generates income to pay for its work. It is not funded by taxpayers through government spending.
The Bank publishes accounts on the same basis as a normal company. It pays corporation tax on its profits and a dividend to the Treasury as shareholder.
The Bank earns money from:
- Interest on government bonds it holds
- Charges for banking services to other institutions
- Income from foreign currency operations
- Fees for regulatory services
Ownership and governance
The Bank is owned by the UK government but has specific statutory responsibilities for setting policy. A Court of Directors (similar to a board of directors) governs the Bank and sets strategy.
Parliament’s House of Commons Treasury Committee publicly holds the Bank to account. It regularly asks the Governor and other senior representatives to explain how and why they arrive at decisions.
The Bank’s independence means it can make monetary policy decisions without political interference, while remaining accountable to Parliament for its actions.