This conversation took place in Spain in the 1820s. Borrow is talking to a former official of the Spanish Inquisition, which had been abolished by Napoleon a few years previously. The passage is obscure but in it the official describes the policy of the Inquisition about homosexuality: it is far from intolerant and indeed is almost exactly that of the Church of England at the present day. As for the clue: nobody expects the Spanish Inquisition.