Glossary: The Bank of England

The Bank of England (known as the BoE or the Bank) is the central bank of the UK. In May 1997 it was granted by the government operational independence to meet an inflation target. But the Bank does not enjoy full independence: the government decides what constitutes an acceptable level of price pressure and retains an emergency right to fix rates.

Functions

The Bank determines and implements monetary policy and it is responsible for the supervision of banks and wholesale money market institutions. It also collects monetary and banking statistics, prints the country's bank notes and has close links with the financial markets.

In May 1997 the government announced that responsibility for banking supervision would be transferred from the Bank to a new body, the Financial Services Authority (FSA), by 1999.

Structure and Personnel

The Monetary Policy Committee (MPC), set up in May 1997, is responsible for formulating monetary policy.

The MPC has nine members: the governor of the Bank Eddie George; deputy governors David Clementi and Mervyn King; two of the Bank's executive directors Ian Plenderleith and John Vickers; and four outside experts, namely Willem Buiter, Charles Goodhart, DeAnne Julius and Sushil Wadhwani.

Monetary and exchange-rate policy

The MPC has to set interest rates to meet a long-term inflation target set by the government. The target is currently an annual inflation rate of 2.5% or below, measured by the retail price index excluding mortgage repayments.(RPIX).

Individual MPC members' stances on inflation are closely scrutinised for clues to the direction of rates. The minutes of each meeting and a record of the formal votes taken, published six weeks after each meeting, often contain market-moving information.

Although the Bank has gained a great deal of independence, political influence can still be exerted by moving the inflation target and by appointments to the committee. Members will eventually be chosen on a rolling basis.

Exchange-rate policy is the responsibility of the UK government, not the Bank. It is the government that owns the UK's gold and foreign-exchange reserves. But if the government wishes to intervene in the markets it does so through the Bank.

Instruments and interest rates

The BoE influences interest rates by setting the pre-announced discount rate at which it deals with the market. The interest rate at which the institution offers funds to banks and discount houses is decided at the monthly MPC meeting by majority voting. The governor casts the deciding vote if the committee is split.

MPC meetings take place on the first Wednesday of each month, and last for two days. The outcome is normally announced at 12:00 GMT on the Thursday.

Once a decision to shift monetary policy has been made, the Bank implements the new rate as soon as possible through its money-market operations.

Each morning the BoE forecasts the size of the market shortage: the amount of cash clearing banks and discount houses will need that day. In recent months this figure has fallen between £300m ($498m) and £2.1 bn. The BoE's interest rate determines how expensive it will be for financial institutions to raise funds to meet its daily cash requirements.

Official interest rates are set via gilt repos. Institutions borrow from the Bank by selling gilts, for which they receive cash, and agreeing to buy them back later. The cost of borrowing in this way is the repo rate.

The Treasury and bonds

The Bank of England was established over three hundred years ago to help the UK government borrow money, and has played a key role in issuance ever since. However from April 1 1998 all debt-management functions were transferred to a new government agency.

UK government bonds are known as gilts (from the gilt-edged certificates purchasers used to receive). Most debt is issued as standard fixed-income bonds, classified according to maturity.

Shorts have less than seven years to maturity.

Mediums have between seven and fifteen years to maturity. Options and futures on bonds of between ten and fifteen years maturity are traded on the London International Financial Futures Exchange (LIFFE).

Longs have longer than fifteen years to maturity.

The gilt market is also the largest index-linked debt market in the world. Here, bonds have the interest payment and the principal sum increased in line with price rises, to maintain their value.