Flying the nest – twenty years of independence for The Old Lady

Twenty years ago this month, buoyed by a historic landslide victory in the 1997 general election, Chancellor of the Exchequer Gordon Brown made the surprise announcement: the Bank of England (BoE), affectionately referred to as The Old Lady, would become independent for the first time in its history.

The plans for independence were made in great secrecy. According to Mervyn King, the BoE governor at the time, Eddie George, was only told about it the day before Brown announced the decision. However, the move was hailed by both the BoE and financial markets, strengthening its credibility and creating more stability around monetary policy decisions.

Coping with crisis

However, perhaps the most volatile period over the past twenty years was the 2008 financial crisis and the subsequent fallout. This transformed the Bank’s way of working both internally and in its relationship with the politicians, financial markets and other stakeholders.

Some accused the Bank of being slow to respond to the crisis, and Katie Barker, a member of the BoE’s Monetary Policy Committee for nine years, described a “terrible group think” which prevented it from seeing the crisis emerging.

However, the Old Lady’s response to the crisis proved to be defining. A major quantitative easing (QE) programme and a prolonged period of record low interest rates have been the central pillars of the UK’s post-crisis recovery program. Many have since acknowledged have played in underpinning stability and economic growth.

Although there have been changes in personnel and processes in subsequent years, overall, the Bank emerged from the crisis with its reputation enhanced. Post-crisis reforms have further centralised its power, including returning responsibility for prudential oversight to the bank from the now-disbanded Financial Services Authority.

Looking forward

With the arrival of its new governor, Mark Carney, from Canada, the Bank has also improved its working relationship with government and strengthened internal management practices.

This is good news, as major challenges lie ahead for Mr Carney and the central bank. He has already come under unprecedented criticism from some Parliamentarians for his outspoken warnings in the build-up to the EU referendum in 2016.

Managing the markets and the economy as Britain exits the EU will require a careful touch and Mr Carney will no-doubt face high levels of scrutiny from both the press and politicians.

In addition, the Bank is not immune to a growing scepticism in the political class around the whole notion of central bank independence. The response of banks to the financial crisis, particularly QE, has become a political issue in the US, Europe and now the UK Prime Minister Theresa May has argued that it has meant “people with assets have got richer” while “people without them have suffered”.

Given its enhanced role in overseeing banking and monetary policy, some, such as former Strictly Come Dancing star Ed Balls, believe that the blame for the next financial crisis will be placed, fairly or not, squarely at the door of the Bank of England.

Despite the ups and downs, the Bank has helped to successfully steer the UK economy since flying the nest. It is now also transforming itself into a global leader in fintech regulation, setting up a fintech accelerator last year. Recently the bank also launched a plan to de-risk Sterling payments with its blueprint for a new real-time gross settlement system to improve sterling payment.

With careful management and this continued focus on evolving with the rapidly changing financial services market, we look forward to another twenty years of an independent central Bank.

The FX market’s six-month health check is due this week

The Bank of England releases FX trading data from the market for the six months to October last year. That covers a bouncy few months to say the least.

This data set will cover the Brexit vote and the not-entirely-event-free run up to the US election so we’ll be interesting to see what happened with dollar-peso volumes and Sterling which continues to be buffeted by the winds or Brexit and a significant degree of political and economic uncertainty.

These are unprecedented times for the flow and trade of global currencies and the structure of one of the world’s largest and most liquid markets.

The public face of the market has focussed on the conduct of some traders remains in the spotlight following a series of high profile legal cases over alleged malfeasance.

Much of this is being addressed through the Global Foreign Exchange Code of Conduct, led by the Bank for International Settlements.

But it is the changing role of the banks and the funds as makers and takers – the shape-shifting of the formerly API prop traders towards market maker status that, in our view, has delivered the most significant structural change.

Once dominated by the largest global banks, the growth of electronic trading has made it easier for relatively smaller financial firms to become directly involved in currency trading. Access to the market and competing trading venues have exacerbated this process.

Concurrently, regulation has limited the risk these banks can carry on their books, making them more selective about how and with whom they trade.

Currency trading continues to be dominated by what are euphemistically described as “other financial institutions”

This category includes smaller commercial and investment banks, as well as buy-side firms like pension funds, mutual funds and hedge funds. In other words, not the banks.

Broadly, volumes of late have been lower with overall daily turnover declining to around USD 5.1 trillion in April 2016, from USD 5.3 trillion three years ago.

But the there has been a significant uptick in currency market volatility has increased over the past few years.

All eyes on Tuesday to see how the market fared through the events of the latter part of 2016. Expect a few surprises.