LONDON (Reuters) - Bank of England Governor Mervyn King will have a new set of questions to deal with on Wednesday beyond the usual ones about the fragile economy: just how independent is the Bank?
The issue has risen after last week's decision by the government to take profits from the Bank's bond buys and put them in the finance ministry coffers.
King agreed to a finance ministry decision on Friday to take back 35 billion pounds in interest paid to the Bank over the past three years on its 375 billion pound holdings of government bonds, bought as part of its quantitative easing stimulus policy.
On Wednesday -- as well as presenting a quarterly update to the BoE's growth and inflation forecasts -- King is likely to be asked to explain this move which came a day after the Monetary Policy Committee decided not to loosen policy further.
The windfall may allow Chancellor George Osborne to achieve his debt reduction goals. It also amounts to a back-door loosening of monetary policy.
But economists have warned that it carries future costs and further blurs the line between fiscal and monetary policy, putting the central bank's cherished independence at risk.
"Put simply, a decision to unwind QE will now be more problematic for the government -- in the form of larger deficits and financing needs -- than was the case before," Credit Suisse economist Neville Hill said.
"To the extent to which a reversal of QE may now be more costly for the government than was the case before, it clearly raises the risk that the Bank's latitude, ability and willingness to reverse QE when it needs to - to meet its inflation target - will be more limited," he added.
In Friday's agreement, the finance ministry pledged to indemnify the BoE for future losses on the gilts portfolio, which economists think are likely once the central bank tightens policy and sells gilts back to the market.
Nomura economist Philip Rush said the BoE's Funding for Lending scheme, which provides cheap funding to banks if they keep up lending to households and businesses, already raised similar issues as the central bank ran the risk of losses.
For his part, King has stressed that the central bank could only venture into such policies as an agent for the government, because they ultimately put taxpayers' money at risk.
But economists said the recent decision may well feed back into rate-setters' considerations.
"The move on coupons may make the Monetary Policy Committee even more wary in future about expanding asset purchases, given the temptations to monetisation that such a large chunk of public debt held by the Bank has to politicians," said BNP Paribas economist David Tinsley.
Many economists still see Britain's economy in need of more support -- despite the strong exit from recession with 1 percent growth in the third quarter -- after surveys showed fresh weakness across most sectors.
Economists are keen to get King's view on the success of the new FLS scheme as well as on alternative measures, after several central bankers have said gilt purchases looked less effective.
Top bank regulator Adair Turner, who has applied to succeed King at the helm of the Bank next year, has recently fuelled the debate, suggestion a more cooperation across all policy areas might be necessary to fight deflation dangers.
"We agree that more gilt purchases might not do a lot of good," said Capital Economics analyst Vicky Redwood. "But this just means that the Committee should get more imaginative."
Many economists think the BoE's forecasts will leave the door for more outright quantitative easing asset purchases open.
"Mervyn King's usual dovish overlay could compound this message with a reminder that the fire-fighting MPC will respond if recent positive signs fade," Nomura's Rush said.
A Reuters survey showed that economists predicted the Bank to leave its forecast largely unchanged to show annual growth of 2.0 percent and inflation at 1.8 percent at the end of 2014, below the 2 percent goal and signalling leeway for more action.
King's news conference will start at 10.30 a.m. British Time, after the publication of the quarterly forecasts in the Inflation Report.
(Reporting by Sven Egenter. Editing by Jeremy Gaunt.)