MNI INSIGHT: BOE's QT Pace Known, Terminal Point Unknowable

The Bank of England is unlikely to provide a precise numerical estimate of the end point for quantitative tightening when it publishes its framework for running down its gilts holdings in August, but it will set a pace for combined sales and redemptions, with the counting set to start from the time active sales begin.

It will also need to provide detail on how it plans to ensure liquidity and avoid a snap back in market rates by maintaining reserve supply if needed as gilt sales proceed.

In his July 19 Mansion House speech, Governor Andrew Bailey said the BOE was looking at reducing the stock of gilts held by GBP50-100 billion "in the first year," sparking debate among analysts over whether redemptions prior to active sales would be included. But, as the Bank will not want to sell substantial amounts of gilts at the same time as large redemptions fall due, the straightforward interpretation of his comments is that the count will only commence once active sales begin, possibly in September.

The BOE’s Monetary Policy Committee decided at its February meeting to begin shrinking the stock of government bonds by not reinvesting proceeds of maturing gilts, and by the August meeting its holdings will have dipped below GBP844 billion, from a peak of GBP875 billion.

NO NUMERICAL TERMINAL POINT

Even as it sets a pace for sales in August, questions will remain as to how long the Bank expects sales to go on and how far balance sheet shrinkage could extend.

The BOE, through its market intelligence side, has asked banks about the levels of reserves they think they will require. But the experience of the U.S. Federal Reserve, which found in 2019 that money markets froze when reserves were still at levels well above those banks had suggested would be required, highlights the dangers of placing too much weight on the expectations of financial institutions, which tend to underestimate their own future needs.

Central banks will be very cautious with quantitative tightening, as former senior BOE official David Aikman told MNI in a recent interview, in which he noted that they will probably err on the side of leaving balance sheets slightly too large over the next five to 10 years. (See MNI INTERVIEW: Risk BOE Gilt Sales Spark Volatility – Aikman)­­­

As it releases its gilt sales framework, the BOE will also be expected to detail mechanisms to ensure a sufficient supply of liquidity to markets if needed.

In a speech last September, the Bank’s Executive Director Markets Andrew Hauser pointed to the existence of an unknown level of reserves below which short-term market rates would jump significantly above the target interest rate, undermining monetary policy. While the QE unwind would not need to stop when reserves hit that level, the BOE would need to replace long-duration QE assets with shorter-term repos or other Open Market Operations to maintain the size of the balance sheet, Hauser said.