MNI INTERVIEW: Risk BOE Gilt Sales Spark Volatility - Aikman

The Bank of England should get on with shrinking its balance sheet, even if quantitative tightening is more likely to prompt market volatility than some at the BOE had hoped, the Bank’s former technical head of division, David Aikman, told MNI.

With the BOE set to launch its framework for active gilt sales in August, some officials have argued that the effect on liquidity and bond yields from active gilt sales should be minimal, given that the main effect of quantitative easing had been to restore liquidity to markets via a flow of purchases. But a rival view, expressed by Stanford Professor Hanno Lustig at a conference hosted by Aikman last week, is that a decade of unconventional monetary policy may have suppressed interest rates at artificially low levels, and yields may snap back once stocks of bonds begin to fall.

"That argument would suggest the signal we are deriving from markets right now is hugely distorted by the fact that central banks own lots of the asset class that we are talking about here. It does give us a little bit of pause in thinking about what the right strategy is for the Bank from August onwards," said Aikman, now director of the Qatar Centre for Global Banking and Finance,

"I still think it is the right thing to get on with unwinding the balance sheet,” he added in an interview. "If anything, we have waited too long to begin this process. There are risks to maintaining a very large balance sheet. There are risks basically to the independence of the institution if we continue in the state of the world where a vast amount of the gilt market is owned by the Bank of England." (See MNI INTERVIEW: BOE Gilt Sales Should Be Slow, Steady - Forbes)

PROCEED, BUT WITH CAUTION

Still, central banks should monitor the impact on yields and liquidity as they proceed with quantitative tightening, he said.

"I think central banks will have a lot of caution in the way they approach this, rightly so. Given what we saw with U.S. money markets seizing up in September 2019, we’re likely to end up with a slightly too large balance sheet over the next five to 10 years," he said.

The Bank has to decide whether to include an estimate of what the endpoint for balance sheet shrinkage will be when it publishes its sales framework.

Aikman believes that it should, at least, set out the factors that they are looking at to try and establish that endpoint, such as banks’ need to meet liquidity capital requirements, and that “will let people form their own views as to where that terminal point should be," he said.

Despite years of experience with quantitative easing, central bankers are still unsure as to its mechanisms, Aikman noted.

“Whether the effects on markets and the economy derive from the stock of QE or the flow of QE .. it is still unknown if we are being totally honest. The flow view would suggest that you should probably have already begun the unwinding and you just get on with it,” he said, following a conference at the centre which included BOE Chief Economist Huw Pill and many others.

"We have heard arguments that cast some doubt as to whether this view is correct … that suggest the effects arise much more from the stock of purchases that are sitting on central banks’ balance sheets," Aikman said.