Bailey braced to defend Bank against next Tory leader

Threadneedle Street faces its greatest challenge since independence amid push for reform, finds Simon Foy

Andrew Bailey’s patience is wearing thin. At a sitting of the Treasury select committee last week, the Governor of the Bank of England was forced to hit back against Tory leadership hopefuls who are increasingly turning their ire on Threadneedle Street.

After Tom Tugendhat claimed the Bank’s programme of quantitative easing (QE) was to blame for the inflation crisis, Bailey took a not-sosubtle swipe at the Conservative backbencher.

“I’m afraid I don’t subscribe to the view that QE is responsible. But I’m not going to join in that debate,” he told MPS, stony-faced.

In the melee to replace Boris Johnson as Tory leader and Prime Minister, Threadneedle Street has become a growing target – something that would once have been highly unusual. It is facing its greatest challenge since independence, forcing Bailey to fend off reforms and criticism over the current economic crisis.

Liz Truss, the Foreign Secretary, one of the frontrunners in the contest, said over the weekend that she would “set a clear direction of travel” on monetary policy, which many observers took as a veiled challenge to the Bank’s independence. The Treasury sets the 2pc inflation target, but the Bank has been independent since 1997.

Threadneedle Street is no longer taking these apparent threats lying down. Yesterday, Michael Saunders, one of nine on the interest rate-setting Monetary Policy Committee (MPC), issued a broadside against Truss and others, telling them to leave the Bank alone to set interest rates.

Responding to the criticism, he said: “The Government very clearly does not set the direction of travel for monetary policy. That’s set by the independent MPC in order to achieve the 2pc inflation target and that’s fundamental to the UK’S framework. There’s a debate always about [whether interest rates will] go up or down. But the foundations of the UK monetary policy framework, I think, are really important and best left untouched.”

He added that Britain’s monetary policy credibility was at stake: “The MPC’S ability to loosen monetary policy promptly and effectively during the recession of 2008-09 and during the pandemic rests on the credibility of that policy framework.”

The latest political attacks against the Bank form part of a wider rift between the Government and rate-setters that has been growing for months. At the heart of the tension is a blame game over spiralling inflation, which last month hit a four-decade high of 9.1pc.

While most major economies are struggling with surging inflation, Bailey has come under particular fire for how the Bank has handled the crisis. Last year, before the MPC started raising rates, it was accused of repeatedly wrong-footing markets due to its “confusing” communications strategy. In May, analysts at Bank of America condemned the Bank’s “increasingly challenging” communications.

Ministers have also accused it of blocking a wave of post-brexit reforms, while a new Bill has been mooted for them to overrule decisions – something Bailey has expressed concern about.

Government insiders have said they are particularly concerned about the approach taken by the Prudential Regulation Authority (PRA), part of the Bank set up to police the financial system following the 2008 crisis.

They warned its slow response to demands for an overhaul of Eu-era insurance rules, called Solvency 2, is symptomatic of a wider institutional reluctance to embrace Brexit freedoms.

In February ministers announced plans to relax the controversial Solvency 2 rulebook, which was introduced by the EU in 2016 and requires UK insurers to hold vast sums of cash on their balance sheets.

Insurance has been touted for years as a beneficiary from relaxing the rules and industry bosses have pledged to unleash a £90bn-plus investment “Big

‘I’m afraid I don’t subscribe to the view that QE is responsible. But I’m not going to join in that debate’

Bang” if ministers slash EU red tape. Insurers and pension funds have argued the current restrictions mean they are unable to plough as much capital as they want into illiquid assets like infrastructure.

However, there are growing concerns that regulators are holding up the reforms, with Johnson said to be getting increasingly impatient with the PRA who he views as excessively cautious. The PRA has remained steadfast. Sam Woods, deputy governor of the Bank, said earlier this month that any reform of insurance capital rules should not be a “free lunch” that puts pensioners and policyholders at risk.

Proposals to loosen Eu-era rules, boosting the City of London’s international competitiveness, are largely welcomed in the Square Mile. Simon Morris, a financial services partner at City law firm CMS, says: “The Treasury is definitely right to go for a second ‘Big Bang’. Margaret Thatcher’s Big Bang re-established the City as a global financial centre. The present plans are more modest but no less needed. Now out of the EU, we have a major redesign opportunity.”

A radical new mechanism in the Financial Services Bill, which is set to be published tomorrow, would allow ministers to reverse decisions by financial watchdogs if they threaten to hold up reforms. One area where the new “call-in power” could be invoked is around an overhaul of the controversial Solvency 2 rulebook.

However, there are some who aren’t convinced the Treasury’s power grab sets a good precedent – and not just Bailey. One FTSE 250 chief executive says: “Instead of ‘call-ins’, which could go the wrong way, I would have clarified the mandate of the regulators.”

CMS’S Morris adds: “The regulators and not the state should make the rules. They are closer to the market and can move like lightning when it suits them.”

The Bank is only now starting to publicly push back against incoming offensives. Yet it is attempting to do so in a way that does not allow bubbling tensions to spillover into all out war.

Yesterday, Saunders admitted that the UK might be slightly better placed in terms of inflation expectations had the Bank ended the QE programme earlier, but added: “The current inflation rate would not be very different.”

Both sides will have to come face to face when Nadhim Zahawi, the Chancellor, and Bailey give keynote addresses at the City’s Mansion House dinner tonight.

While temperatures in the gilded Egyptian Hall are likely to soar as London sizzles, the two men will be hoping to keep any private hostilities cool in front of the Square Mile’s top brass.