Latest / Monetary Policy Explained with Fexingo: Central Banks, Money Supply, and Interest Rates / Why Central Banks Care About the Bank of England
Transcript
- Lucas: So, when we talk about central banks, we usually talk about the Fed, or the ECB, maybe the Bank of Japan. But the original — the one that really invented the playbook — is the Bank of England. And it's having a fascinating August 2026. Luna: Right, the Old Lady of Threadneedle Street. I feel like we've referenced it, but we've never actually done a deep dive on how its structure shaped everything else. Lucas: Exactly. So let's start with the founding. 1694. The Bank of England was set up to fund a war against France — William of Orange needed a loan. A group of London merchants lent him one point two million pounds, and in exchange they got a royal charter to run a bank. Luna: It's wild that the most important central bank in history started as a war-financing scheme. And it wasn't even a central bank then — it was just a bank. Lucas: Right. It was a private bank with a special relationship to the government. It slowly gained privileges — like being the only joint-stock bank allowed in England for a while — and it became the banker to the government. By the nineteenth century, it had effectively become the lender of last resort, which is the core idea behind modern central banking. Luna: So when did it become 'the' central bank, in the modern sense? Lucas: That's a great question. The formal nationalization came in 1946, after World War Two. But the real modernization happened in 1997, when the Labour government gave it operational independence. That's when it got control over interest rates. And that's actually the model most central banks follow today: a politically appointed governor, but independent decisions on monetary policy. Luna: And that's the key difference between the Bank of England and, say, the Fed, right? The Fed has that dual mandate — maximum employment and stable prices. The Bank of England is just inflation targeting. Lucas: Yeah, exactly. The Bank of England has a single mandate: price stability, defined as a two percent inflation target. It was actually the first major central bank to adopt explicit inflation targeting, back in 1992. The Fed under Volcker did something similar in practice, but they never formalized it that way. So the Bank of England really set the template for the 1990s and 2000s wave of central bank independence. Luna: And that inflation target is measured by the CPI, right? The consumer price index. But they also look at things like the output gap and the labor market. Lucas: Right. The Monetary Policy Committee — the MPC — meets eight times a year. They have a governor, and a group of economists and external members. They vote on the policy rate, and they also take decisions on asset purchases — quantitative easing. Luna: Which is interesting because the Bank of England was one of the pioneers of QE. They started buying bonds in 2009, in the aftermath of the financial crisis, before the Fed's first round, actually. Lucas: Yeah, that's a good point. The Bank of England's first foray into QE was in March 2009, and they eventually bought up to 895 billion pounds worth of assets, mostly government bonds, by the end of the last expansion. And they've had to unwind some of that recently, but it's been a slow process. Luna: Now, in August 2026, what's the situation? Inflation has come down from the double-digit highs of 2022 and 2023, but it's still above the two percent target. What's the Bank of England doing? Lucas: Right. The Bank of England, like other major central banks, has been in a tightening cycle. They raised rates aggressively in 2022 and 2023, and then they started cutting a little bit in late 2024 and 2025. But they're being cautious. They don't want to cut too fast and risk inflation re-accelerating. And there's also this whole issue of quantitative tightening — selling off the bonds they bought during QE. Luna: And that's been a pretty controversial part of their strategy, hasn't it? Because they're actually selling bonds at a loss, which means the losses are borne by the taxpayer in a way. I think the Bank of England has already transferred losses to the Treasury. Lucas: Yes, that's a really unique aspect. The Bank of England's asset purchase facility is indemnified by the Treasury. So when interest rates went up and the value of those bonds fell, the Bank of England made massive losses. And those losses are covered by the government. It's a bit different from the Fed, which just holds its losses on its balance sheet. Luna: That feels like a very British way of doing things — the government kind of absorbs the risk. But it also means there's a political dimension to the Bank's actions, right? Lucas: Well, that's the thing. The Bank of England is independent, but it's not absolutely independent. The government sets the inflation target, and the Bank has to achieve it. And there's always this tension between political pressure and central bank credibility. Look at 2022 — when the Bank was being criticized for not acting fast enough, and then came the Truss mini-budget crisis. That really tested the Bank's independence. Luna: That's a perfect example. The market basically forced the Bank to intervene with a temporary bond-buying program to stabilize the gilt market. That was an emergency use of its balance sheet, not a monetary policy decision per se. Lucas: Exactly. And that's a great illustration of the distinction between the Bank's monetary policy role and its financial stability role. It has a dual role, even if the mandate is single: it's responsible for both monetary policy and financial stability. And those two can come into conflict, as we saw in September 2022. Luna: So, looking at the broader picture, how does the Bank of England's governance compare to other central banks? I'm thinking about the Fed's structure with the regional banks, or the ECB's governing council. Lucas: Let's break that down. The Bank of England is a unitary institution — it's one entity, headquartered in London. It has a Court of Directors, which is like a board, and the MPC makes monetary policy decisions. The Fed, by contrast, has twelve regional banks and a Board of Governors in Washington. The FOMC — the Federal Open Market Committee — includes the regional presidents, which gives it a more federalized structure. The ECB is even more complex, with national central banks of the eurozone member states. Luna: So the Bank of England is simpler, but that also means it's more concentrated. The governor has a lot of power, especially if they can build consensus on the MPC. Lucas: Absolutely. And the governor is a very public figure — they have to testify before Parliament, and they get grilled by the Treasury Select Committee. That's a key accountability mechanism. Plus, the Bank's Monetary Policy Committee publishes minutes and forecasts, and there's a lot of transparency. But it's still a small group of people making a big decision. Luna: And one thing I've always found interesting is the Bank of England's role in the financial system beyond just setting rates. They supervise banks, they issue banknotes, they manage the UK's foreign exchange reserves. It's a lot. Lucas: Yeah, and they've also been at the forefront of digitization. They're working on a central bank digital currency — the digital pound. That's a topic we've covered in past episodes, but it's interesting to see how the Bank of England is approaching that, with a very cautious, consultative process. Luna: And they also have a role in promoting financial inclusion and addressing climate risks. Those are more recent additions to their remit. Lucas: Right. And that expansion of the central bank's role is one of the big debates in monetary policy circles right now. Some people argue that central banks should focus narrowly on price stability, while others say they have to take into account financial stability and climate risks. The Bank of England has been pretty proactive on climate stress tests, which we've discussed before. Luna: So, given all this, what should our listeners take away from this episode? I mean, they might never interact with the Bank of England directly, but its decisions affect their mortgages, their savings, the cost of living. Lucas: Yeah, and that's the point. The Bank of England's policy rate directly influences the variable mortgage rates that millions of people in the UK have. And even if you're not in the UK, the Bank of England's actions affect global bond yields and the pound, which ripples through global financial markets. So understanding how this institution works is really understanding a key node in the global financial system. Luna: And it's a great lens to understand central banking in general. The Bank of England has been through wars, financial crises, Brexit, a pandemic — it's seen it all. And it's still evolving. Lucas: Absolutely. And that's why it's worth paying attention to. So, next time you hear about the Bank of England cutting rates or worrying about inflation, you'll know the history behind it, and the tools it's using, and the constraints it faces. Luna: And you'll know why it's called the Old Lady. There's a story there, right? Lucas: Yes, the nickname comes from a 1797 political cartoon, where the Bank of England was depicted as an old lady, dealing with the fallout of war financing. It stuck. So, you get a history lesson and a central banking lesson in one. Luna: I love that. So, if this episode helped you understand central banks a little better, maybe you'd consider supporting the show. We keep it ad-free, and that's only possible because of listeners like you. If today's episode was worth a coffee to you, you can find us at buy me a coffee dot com slash fexingo. And honestly, that's the smallest ask — even a dollar helps keep us going. Lucas: Yeah, we really appreciate it. And it keeps us free of ads, so we can dive into topics like this without any corporate sponsorship. But now, let's get back to the Bank of England, because there's one more thing I want to highlight: the Bank's approach to its own balance sheet in 2026. Lucas: So, the Bank of England has been actively unwinding its quantitative easing program. They've been selling off gilts, and that's a process called quantitative tightening. And it's a delicate dance because you want to reduce the balance sheet without disrupting markets. They've been doing it gradually, and they've also been, I think, fairly transparent about their plans. Luna: And that's different from the Fed, which has been able to let its holdings mature without necessarily selling actively. The Bank of England has been more proactive in selling. Lucas: Yes, and that's partly because the size of the Bank's QE program was very large relative to the UK economy. It was almost forty percent of GDP at one point. So unwinding that is a big deal. And it also means there's a potential conflict with fiscal policy — as the Bank sells bonds, it could put upward pressure on yields, which makes government borrowing more expensive. So the Treasury is very much watching what the Bank does. Luna: So, the Bank of England has to navigate this very carefully. And it's not just about inflation; it's about financial stability and the relationship with the government. Lucas: Exactly. And that's what makes central banking so fascinating — it's not just an economic exercise, it's deeply political and institutional. So, I think the key takeaway is: the Bank of England is the oldest central bank in the world, it's been a pioneer in many ways, but it's also facing the same challenges as other central banks — balancing inflation, growth, and financial stability — all while maintaining its credibility and independence. That's a tough act. Luna: Well said. And next time you hear 'Bank of England,' you'll think of that old lady, but also of a modern institution trying to find its way in a complex world. Lucas: Absolutely. And with that, we'll leave you. Thanks for joining us on this episode of Fexingo's Monetary Policy Explained. Until next time.