Bank of England

Osborne Paves Way for Carney to Retool Bank of England

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British finance minister GeorgeOsborne has laid the groundwork for a partial revamp at the Bankof England when new Governor Mark Carney arrives in July, butmore radical options remain off-limits.

Trying to keep consumer price inflation at 2 percent willcontinue to be the central bank's main job, even after thebiggest change to its monetary policy remit since it gainedoperational independence in 1997.

The new mandate Osborne announced on Wednesday is in manyways a tidying-up exercise, giving formal backing to the centralbank's current practice of letting inflation overshoot itstarget if the alternative would be an economic slump.

Carney may also be able to import new tactics such as makinglong-term commitments to low interest rates which he haschampioned at the Bank of Canada and have found favor at theU.S. Federal Reserve.

Britain's economy has been stagnant for the past two years,in the face of Bank of England bond buying and schemes to boostlending, fueling speculation Osborne could order major change.

But despite his mantra of "monetary activism with fiscalresponsibility", Osborne did not ask the central bank to targetgrowth as well as inflation, stressing "the primacy of pricestability and the inflation target".

(Read More: Britain's Growth Halved, Osborne Turns to Bank of England for Help)

The head of Britain's debt agency - who will be responsiblefor selling around 151 billion pounds of government bonds in thecoming year to fund the country's budget deficit - told Reutersthe news would reassure investors.

Some in financial markets had speculated Osborne could askthe BoE to adopt a Fed-style dual growth and inflation mandate,or to target a new measure of inflation which includes housingcosts and has been persistently lower than the existing measure.

The pound rose in value against the dollar on Wednesdayafter the remit announcement as investors took it to represent asmaller move than some had feared.

"The new remit is more a clarification than a change inmandate," said Investec economist Philip Shaw. "The changes aresensible, and therefore welcome ... but at this stage it isdifficult to conclude that they represent a shift to 'monetaryactivism' as the chancellor claims."

Ed Balls, finance spokesman for the opposition Labour party,quipped that it was Osborne who needed to change his remit, notthe BoE, and a senior Treasury official acknowledged that thenew remit amounted to "evolution rather than revolution".

The British central bank has been innovative since 2009,when it launched a program of asset purchases with newlycreated money - also known as quantitative easing - which hassucked up 375 billion pounds of government debt to date.

Forward Guidance?

The biggest change in the new remit is a request for thecentral bank to publish a report in August into the merits ofusing so-called "state-contingent intermediate thresholds".

Translated into plain English, this could mean committing tobuy more government bonds until unemployment falls below acertain level or inflation rises well above its target.

The Fed and the Bank of Canada have done this sort of thingsince the financial crisis. But the BoE has avoided it becauseof doubts over whether it was consistent with its remit, and astrong reluctance from long-serving Governor Mervyn King andother officials to pre-commit to policy moves.

The Bank of England may find it easier to make this changewhen Carney arrives, said Rob Wood, a former BoE economist whonow works for Berenberg Bank, possibly easing the launch of morebond-buying.

"The chancellor has crossed his fingers and is waiting forthe cavalry, in the shape of Mark Carney, to come and save theday," he said.

"Forward guidance is Carney's calling card. As practiced bythe Fed, an example Osborne specifically referred to, guidancecomes hand in hand with further asset purchases, so we continueto expect ... more asset purchases after Carney takes over."

However he will still have to get the other eight members ofthe Monetary Policy Committee (MPC) on board, which may provetougher than in Canada.

Not only are MPC members encouraged to make theirdisagreements about the right course for policy public - unlikein Canada - but some have said they see little reason formarkets to believe long-term policy commitments that areintended to outlast the policymakers themselves.

Shortly before the new remit was published on Wednesdayminutes of the BoE's last policy meeting showed officials splitover further asset purchases. Some worried they could furtherweaken sterling, which has already lost around 7 percent againstthe dollar this year, and push up inflation.

(Read More: Sterling Seen 'Properly Valued': Bank of England's King)

Other changes to the remit are more minor, and are likely tofind greater consensus on the MPC.

The new remit makes clearer that inflation may sometimesexceed its target, but also places a greater onus on the MPC toexplain what trade-offs it is making when it allows inflation todo so.

The MPC must also take account of the BoE's new financialsupervision powers which come into force in April.

Although another bank committee has most of the tools tocontrol financial bubbles, the MPC is also now allowed to takeaction such as raising interest rates to pop an asset bubble ifother tools fail.