Five things to know about the Bank of England

The Bank of England is the central bank of the United Kingdom. Its main purpose is to set monetary policy that determines the economic growth and price stability in the region. The actions from the Bank of England directly impact its currency, the British pound sterling, also known as the GBP.

The Bank of England, or the BoE is headquartered in the central financial district of London. The central bank was established in 1694 incorporated by the act of Parliament. It was set up for the initial purpose of raising money to fund the English wars. By the 1730's the BoE moved to the Threadneedle street.

Over time, the BoE earned the nickname as the Old lady of Threadneedle Street.

The Bank of England is quite active as it sets monetary policy. Therefore, for traders in the FX markets, if you want to trade the GBP currency, it is essential that you understand what the Bank of England does and how its actions can influence the currency.

1. What is the Bank of England’s monetary policy composed of?

The policy setting committee of the Bank of England comprises of nine members including the Governor of the central bank. Besides the governor, there are three deputy governors for monetary policy, financial stability and markets and banking.

There is also one chief economist and four external members. These external members are appointed by the Chancellor of the Exchequer and their term is renewed every three years. Each of the nine members have a vote on the monetary policy.

2. How does the Bank of England set up monetary policy

What is unique about the Bank of England is the fact that the central bank uses an explicit 2% hard ceiling on the inflation rate. This means that every time inflation overshoots the 2% target rate, the BoE governor needs to send an explanation to the Chancellor of the Exchequer.

The BoE meetings every six weeks or about eight times a year. The meetings usually happen on a Thursday. Following a decision, the central bank also issues the meeting minutes and holds a press conference.

3. Types of rates that are determined by the BoE

The interest rate determined by the Bank of England is called the Bank rate. The Bank rate is the rate at which institutions can borrow or lend to each other.

It is also known as the Bank of England's base rate or the interest rate. When the bank rate changes, it impacts the savings and borrowing rates from commercial and retail lenders. The changes to the bank rate are determined by gauging the economy.

The main focus is of course on maintaining the price stability. Unlike most other central banks, the Bank of England does not have a dual mandate. Therefore, monetary policy decisions are determined by looking at the inflation rate and the inflation expectations.

4. The most important indicator for the UK’s monetary policy

As it might be obvious by now, the inflation or the Consumer Price Index is the most important economic indicator for the UK. This is followed by the unemployment rate and eventually runs into the GDP.

As traders who are trading the GBP primarily, it is essential that one should monitor the inflation rates. The inflation data is published every month by the UK’s Office for National statistics or the ONS. While the inflation rate shows the headline and core inflation as of the previous month, other leading indicators include inflation expectations.

The inflation expectations tend to lay the groundwork to estimate what future inflation will be.

5. The BoE monetary policy tools

Besides setting interest rates or the Bank rate, the Bank of England in recent times has also dug into various other monetary policy tools. One of these include the central bank’s asset purchase program, which started after the 2008 global financial crisis.

The BoE purchases bonds in an open auction with various commercial banks participating. The sale of these bonds allows the BoE to transfer liquidity from the central bank to the commercial banks and then later on into the broader economy.

Besides the above, the BoE of late is also looking into the option of using negative interest rates. As a trader concerned with the GBP, one should pay attention to the speeches from the BoE monetary policy members as well.