Problems mount for Bank of England governor after weathering Covid storm

Andrew Bailey’s challenges as governor of the Bank of England are mounting as he enters his second year in the job, having successfully helped to steer Britain’s economy through the initial storm of the coronavirus pandemic.

With the bond market in meltdown on his third day in the job last March, he realised the enormous responsibility of being governor when the financial stability team came into he office saying “we need to talk”.

“That’s never good,” he recalled.

Taking emergency action three times in eight days, the BoE managed to prevent a public health emergency becoming a wider financial crisis.

Jagjit Chadha, director of the National Institute of Economic and Social Research, a think-tank, said: “In firefighting, the BoE learned its lessons from the [2008] financial crisis — do it quickly, do it large, ensure financial market liquidity and allow fiscal policy to have maximum traction.”

As he marks his first anniversary as governor, Bailey has a new list of difficulties to confront. Explaining the future strategy for monetary policy has been a persistent and troublesome thorn in his side. On top of this, Bailey has to manage the legacy of financial scandals from his time running the Financial Conduct Authority, the fallout of Brexit on the City of London and a desire to become a climate champion.

With interest rates at 0.1 per cent, their lowest in the bank’s 327 year history and having doubled quantitative easing from £445bn a year ago to a total of £895bn planned by the end of this year, Bailey often argues the BoE has “ample firepower” to stimulate and support the economy as it recovers from Covid-19.

But the central bank has been reeling from stinging criticism from its internal watchdog that it had serious “knowledge gaps” in understanding how QE worked, and an inability to explain the effects of the scale of asset purchases.

Paul Tucker, BoE deputy governor from 2009 to 2013, said the BoE appeared poorly prepared despite having more than a decade to understand QE’s effects.

“Ten years on, you would expect there to be an avalanche of research on that, the central instrument of the MPC,” Tucker told a Lords’ committee last month.

There has been a tension in the past year between financial market participants who believe the key way that QE was effective was in enabling the government to borrow at a huge scale and Bailey, who routinely insists he is not in the business of using central bank money to finance the government.

Karen Ward, chief European market strategist at JPMorgan Asset Management and a former adviser to Philip Hammond as chancellor, said the financial markets were right, but the UK was “extremely fortunate” that Bailey had allowed monetary policy to support the government in a crisis.

“There are times when central banks should not be remotely independent of government,” Ward said.

If QE has been a success of policy but not communication, critics say the year-long debate over the possibility of introducing negative interest rates has been neither. The BoE will not be in a position to set a negative interest rate until August, a year after Bailey said the policy was already in its toolbox and 18 months after the pandemic started.

Richard Barwell, head of macro research at BNP Paribas, said: “It is hard to explain why the bank will not be ready to take rates into negative territory until almost 18 months after the start of the pandemic and around seven years after the European Central Bank went negative.”

Bailey’s relationship with the government has, by most accounts, been positive. Occasional irritation in the Treasury over public suggestions from the governor over what to do with the Covid-19 loans to companies and the furlough scheme have been more than offset by his supportive stance on Brexit and the City.

However, Bailey seems to be taking what one senior banker described as an “increasingly curmudgeonly” attitude to Brexit.

“His recent remarks, which were quite provocative, have caused a lot of alarm in the City,” says a former UK regulator who dealt with the EU. “Instead of cooling things down, as firms were hoping, he has stirred it up.”

With UK and EU relations deteriorating over trading arrangements for Northern Ireland, the City is anxious that Brussels will not grant a series of equivalence deals that will allow Britain to trade more freely in Europe’s financial services market following Brexit.

Inside the bank, however, officials are generally pleased with his management style, describing him as a “good bloke” after six years of reports of shouting and “nuclear explosions” emanating from the governor’s office under Mark Carney.

However, in the months ahead the governor must deal with the legacy of scandals from his time running the FCA. Two scandals refuse to die for Bailey: the collapse of London Capital & Finance, which pushed unregulated mini bonds on pensioners; and the implosion of Neil Woodford’s flagship investment fund.

On both, the FCA under Bailey’s stewardship is accused of ignoring red flags and its sclerotic approach, leading to retail investors nursing losses. A former Court of Appeal judge, Dame Elizabeth Gloster, leading an inquiry into the regulator’s response to LCF, found that the watchdog failed in its most basic objective of protecting consumers, prompting the Treasury to set up its own compensation fund.

Bailey has since erupted into a war of words with Gloster over whether he pressed for his name to be taken out of her report when it came to her findings of personal responsibility.

“He’s lucky on the timing, because had the Gloster report come out sooner, he would never have got the governorship,” said one regulatory specialist.

As it is, the two scandals, whilst embarrassing, do not represent existential threats to Bailey. “There is no appetite within Treasury to get rid of him at this stage,” says one adviser familiar with the department’s thinking.

Bailey is keen to put these scandals behind him and, instead, focus on generating his new task of using the central bank’s powers to help the economy move to net zero carbon emissions.

Many central bankers would recoil at the imposition of new mandates that are difficult to integrate into normal work of the central bank, but Bailey was instrumental in lobbying the Treasury to give the bank a new mandate for climate change, according to insiders. He sees this as part of building a successful legacy for the future.