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BOE INSIGHT: BOE MPC QE Unwind Approach Called Into Question

MNI (London)
By David Robinson
     LONDON (MNI) - The Bank of England Monetary Policy Committee will come
under fresh pressure to rethink its approach to unwinding quantitative easing
following the publication of central bank research papers bolstering MPC member
Ian McCafferty's view that policymakers should review their stance.
     The MPC's current approach is that it will not start to reduce its stg435
billion stock of gilts purchases until Bank Rate rises to 2.0%, a level that
market pricing suggests will not be reached over the next five years. A working
paper from one of the BOE's top economists and corresponding work from the
European Central Bank makes the case for commencing unwinding before pressing
ahead with rate hikes.
     McCafferty, who is scheduled to speak later Thursday, said in an interview
back in July that the MPC ought to review its policy of not touching its asset
purchase pile until Bank Rate reaches 2.0%. Neither he nor any of his MPC
colleagues have addressed the issue publicly since then but it is a topic that
is not going away.
     A top Bank economist, Richard Harrison, Senior Advisor in the Monetary
Assessment and Strategy Division, published a paper on optimal quantitative in
late September that broke new ground by creating a formal, welfare based
framework for assessing approaches to QE.  
     Harrison's model will be seen as a framework for future discussions,
forcing dissenters to lay down in details their disagreements with the
     One of the the results from Harrison's model was "that it is optimal to
start reducing the stock of QE before the short-term policy rate has been
increased from the zero lower bound."
     This finding was similar to that derived by economists Matthieu Darracq and
Michael Kuhl at the European Central Bank. In work published in November last
year they concluded that optimal policy behaviour was to stop QE and to begin to
unwind it at or before the date of lift-off for the policy rate. 
     The results of Harrison's model, which explored the differing stock and
flow effects of asset purchases, were compatible with what has happened so far
in the evolution of QE.
     He found that entry into QE regimes can be swift, with large scale asset
purchases getting underway as soon as the policy interest rate hits the
effective zero lower bound. The way out of QE, he noted, is a more prolonged
     "Exit from QE is slower in order to mitigate the costs of changes in
portfolios" and in Harrison's model it should start early in the process.
     The MPC's current approach, however, was spelled out back in the November
2015 Inflation Report. It stated that the committee wanted to use Bank Rate as
the active policy instrument until it reached a level from which it could be cut
materially, and that this level was reckoned to be around 2%.
     The committee did give itself scope to tweak that policy, stating that the
appropriate level for Bank Rate to reach before being cut depended on a range of
factors that were likely to change over time, including the likely impact of
policy changes.
     One option for the MPC would be to cut the level of Bank Rate it deems
needs to be reached before unwinding from the currently envisaged 2.0%. It would
need a substantial cut, as, on the OIS curve the BOE uses to extract market rate
assumptions, it only reaches around 1.25% five years ahead.
     Another option for the MPC would be to do a more comprehensive rethink and
to allow QE unwind to run concurrently with interest rate hikes. Rather than
selling-off gilts, it could start to reduce its stockpile of gilts by ending its
approach of maintaining the stock of QE by replacing maturing gilts.
     If the MPC does not change tack, it would run the risk of doing nothing to
reduce its asset purchase mountain throughout the entire looming tightening
     Harrison's model, unlike others, builds in the assumption that QE has an
upper bound. In the UK under QE the BOE has already purchased around half of the
long-term debt stock and, as Harrison notes, some financial institutions have to
hold long-term safe assets for regulatory requirements, so the upper limit on QE
has to be less than 100% of long-term gilts.
     If the MPC does not reduce QE in this tightening cycle, the next time it
wants to restart asset purchases it will be starting from a high base and could
run up against the regulatory issues.
     McCafferty, as an independent member of the MPC, could step up his calls
for a rethink. Or the Bank could leave new Deputy Governor Dave Ramsden, who was
instrumental in the Treasury's work on QE before switching to the Bank, to take
the lead on the issue.
     With Bank research raising questions about the BOE approach and with the
current policy looking close to "perma-QE" and the first rate hike expected in
November, the internal and external debate over QE unwind looks set to
--MNI London Bureau; tel: +44 203-586-2225; email:
[TOPICS: M$B$$$,M$E$$$,MT$$$$,MX$$$$,M$$BE$]
MNI London Bureau | +44 203-865-3812 |

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