Bank of England Gains Power to Buy Assets as New Tool

By Brian Swint and Svenja O’Donnell

Jan. 19 (Bloomberg) -- The Bank of England won unprecedented powers from the British government to buy assets and expand its policy toolkit to fight the risk of deflation as interest rates approach zero.

The central bank can make initial asset purchases of up to 50 billion pounds ($74 billion), the Treasury said in a statement today. The government will indemnify the purchases against any losses in the facility, which will start on Feb. 2.

The asset program “provides a framework for the Monetary Policy Committee of the Bank of England to use asset purchases for monetary policy purposes should the MPC conclude that this would be a useful additional tool for meeting the inflation target,” the Treasury statement said.

The Bank of England this month lowered the benchmark interest rate to 1.5 percent, the lowest since the bank’s creation in 1694, as Britain faces its first recession since 1991. Today’s announcement may pave the way for the central bank to engage in so-called quantitative easing if lower interest rates fail to stimulate the economy.

Chancellor of the Exchequer Alistair Darling and Bank of England Governor Mervyn King will spell out exactly how the plan will work in an exchange of letters by the end of this month. King will give more details of the program when he delivers a speech tomorrow in Nottingham, England, Prime Minister Gordon Brown told reporters.

The bank will take its next interest-rate decision on Feb. 5, three days after the new plan takes effect. Policy makers will release their quarterly forecasts for economic growth and inflation on Feb. 11.

‘Radical Change’

“This obviously marks a radical change in the U.K.’s monetary policy framework,” said Ross Walker, an economist at Royal Bank of Scotland Group Plc in London. “With bank rate approaching the zero bound, but the wider economy suffering a more severe deterioration, the MPC is being forced into unorthodox policy territory.”

Brown has given authority to the bank to start purchasing assets as part of a broader plan to revive lending as banks recoil in the global financial crisis. The government will also guarantee bank loans and offer capital and asset protection.

As rates approach zero, the central bank will have the authority to channel liquidity to financial institutions by buying assets. The move won’t yet allow the Bank of England to increase the money supply, a tactic recently adopted by the Federal Reserve to fight the risk of deflation, because the purchases are financed by bond sales.

Money Supply

“The money that will go in from the Bank of England will be countered by normal money market operations,” Darling told reporters in London today. In relation to the money supply, “our policy is not changed.”

“The asset purchase facility will provide an important additional tool to improve financing conditions in the economy,” King said in an e-mailed statement.

The Bank of Japan adopted quantitative easing -- the strategy of injecting more reserves into the banking system than needed to keep the target interest rate near zero -- for five years to March 2006. The funds failed to prompt lending by commercial banks, which expanded their reserves at the central bank almost nine times by early 2004.

The U.K. central bank’s Special Liquidity Scheme will expire at the end of the month as previously planned, the Treasury said.

The bank will also extend the maturity of its discount window to one year from 30 days to help banks access liquidity. The fee for using the lending facility beyond the usual 30 days will be an additional quarter-point, the central bank said in a separate statement.

The central bank said it will publish another announcement with details on the discount facility before it starts.

To contact the reporters on this story: Brian Swint in London at bswint@bloomberg.net; Svenja O’Donnell in London at sodonnell@bloomberg.net.