The Bank of England’s role in tackling climate change is under attack. With the economy struggling, and inflation only slowly coming down from a 41 year high, pressure is mounting on the Bank to reduce the resources it dedicates to issues outside the scope of its primary mandate of price stability.
Last week, governor Andrew Bailey announced that the bank would be cutting back on its climate-related work. This follows the chancellor’s decision in November to remove climate change from the list of key priorities outlined in its annual remit letter.
Andrew Bailey’s recent announcement isn’t the first time the Bank has scaled back its climate-related activities in the past year. In March 2023, it announced it would cut spending on climate-related research, amid budgetary challenges, allowing it to focus on its “core operations”. And, a recent report by the House of Lords Economic Affairs committee strongly recommended that the Treasury “prune the Bank of England’s remit”, arguing that requirements for the Bank to “have regards” to climate change distracted it from fulfilling its primary mandate. But the evidence is mounting to suggest the opposite.
In addition to its statutory objectives of ensuring price and financial stability, the Bank has several secondary objectives, including supporting the government’s economic policy and facilitating competition, international competitiveness and growth. The chancellor also issues annual remit letters to the Bank’s monetary policy committee (MPC), outlining which issues the Bank should have regards to in its functions. In recent years, this has typically included a strong focus on climate change.
In 2021, as chancellor, Rishi Sunak announced the ambition to turn the UK into a net zero financial centre, urging the Bank’s financial policy committee (FPC) to take actions “to align private sector financial flows with environmentally sustainable and resilient growth”. The Financial Services and Markets Act, passed in 2023, also added a regulatory principle for the Bank to support the transition to net zero. But, since then, political will has wavered.
The Bank has identified the financial impacts of not actingThe governor’s recent announcement confirmed the Bank would continue its work on climate risks in the context of its mandate to achieve financial stability. However, it would scale back other work relating to the issue. But siloing climate change only to the remit of the FPC overlooks the fact that climate change and biodiversity loss will affect all areas of the Bank’s primary mandate: price stability, financial stability and the safety and soundness of individual financial firms. The Bank’s own Climate Biennial Exploratory Scenario found that banks and insurers could face losses of £334 billion by 2050 in a “no additional action scenario” as the result of both the physical effects of climate change and the risks associated with a poorly managed transition to net zero.
Shocks triggered by climate change, such as flooding or extreme heat, affect price stability, for example by causing spikes in food prices. This puts climate change well within the impact of the MPC. For example, modelling by the European Central Bank estimates that extreme summer heat in 2022 raised food inflation in Europe by 0.7 percentage points. As these events become more frequent and unpredictable, inflation becomes harder to control.
On the other hand, taking early action on climate mitigation and nature restoration will support the Bank’s goal of price stability. Investing in renewables helps guard against inflationary pressures associated with volatile fossil fuel prices. Our analysis found that, had the UK decarbonised its power system in time, the effects of the invasion of Ukraine on UK inflation could have been at least 11 per cent lower in the year 2022-23. But, at present, high interest rates set by the Bank are deterring much needed green investment..,
Central banks across the world are greening their operations, seeing this as vital to achieving their primary mandates. While it is important that the Bank continues to measure and consider the risks climate change poses to the country’s financial stability, it must also take an active role in preventing financial activities from contributing to the problem. It could use prudential instruments to achieve this, such as raising capital requirements – ie the amount of money banks and insurance firms keep in reserve to cover unexpected losses – for those investing in fossil fuels or nature-depletion. This would discourage investment in environmentally harmful activities and ensure banks that continue to invest in them have sufficient liquid capital to cover their operating losses, reducing the overall risk to financial stability. Monetary policies could also be used, such as dual interest rates (lower interest rates for ‘green’ loans) or green quantitative easing, where the Bank buys up green bonds, which helps lower their relative cost.
Nature-related financial risks can’t be ignoredNature also needs to be factored into the equation. The Treasury-commissioned Dasgupta Review, which reported in 2021, demonstrated how much the economy depends on the essential services nature provides, such as clean water and air and resources. Recognising the threat losing these services poses to both price and financial stability, central banks such as the European Central Bank are measuring and modelling the risks. The Bank of England is also working to build a clearer picture of nature-related financial risks facing the UK and decide whether these fall within the remit of the FPC but, as the UK is now one of the most nature-depleted countries on earth, the evidence is mounting that action needs to be taken much faster.
Only three years ago, at the COP26 climate summit, the UK declared to all the countries present its ambition to become the world’s first net zero financial centre, and it was poised to do so. But this ambition has weakened fast. Instead of bowing to pressure to strip down its remit, the government should support and resource the Bank of England to uphold its work on climate and nature in the face of other pressing issues. The risks of not doing so may take years to fully materialise, but how significant they become and how much they hurt the economy will be traced back to decisions made right now.
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