Starmer Needs the Space Only the BOE Can Provide

Flush from a landslide election victory in 1997, the first act of Tony Blair’s Labour government was to grant operational independence to the Bank of England. Chancellor of the Exchequer Gordon Brown followed that up by removing a generous tax credit on dividend income whose prime beneficiaries were pension funds.

Neither change meant much to the average voter, but they triggered a seismic impact on fiscal and monetary policy. After nearly two decades of Conservative government, Blair’s Labour was adhering to strict budget rules but broke free in other unimagined areas to bolster investor confidence and spur corporate investment.

As we approach a similar scenario after 14 years of Tory rule, and Labour riding high in the polls — don’t be surprised if we see a reprise. Call it the Blair Switch Project. Labour leader Keir Starmer and his finance chief, Rachel Reeves, are following the playbook of their electorally successful forerunners to the letter to calm the City of London’s nerves. But expect the unexpected, as the strictures of the UK’s current fiscal predicament are just too limiting for a radical policy agenda.

Reeves has been deliberately vague about her plans, and her pledge to stick to fiscal rules and not raise taxes may not be as ironclad as they appear. Governments have three main levers on which to pull — raising or lowering taxes, spending and debt. The Bank of England could again be the implement that cuts through the Gordian knot of fiscal and monetary stricture.

That’s because the BOE’s structure means any profit or loss from its holdings of quantitative-easing securities pass directly to the UK Treasury. This is markedly different from most central banks, and, importantly, the US Federal Reserve, which retains positive coupon income but also retains the losses from the Treasury bonds on its $7.3 trillion balance sheet.

Bank of England Governor Andrew Bailey made a potentially significant speech on May 21 at the London School of Economics. He flagged that the BOE thinks the amount of its total reserves will drop into an acceptable longer-term band of £345 billion ($439 billion) to £500 billion as soon as next year. That offers clues to how the central bank may start to pull back, or taper, its balance sheet reduction. It wants to move away from holding so many long-dated gilts and replace more with short-term repo lending. It’s encouraging usage of its repo facility, which marks a more permanent transition away from bond buying. There is scope for this to become more radical if a new government were to transform its mandate.