MNI INTERVIEW: Needless QE Boost May Pressure BOE-Ex-Deputy

The Bank of England's expansion of quantitative easing has left UK public finances more vulnerable to a hike in official interest rates, increasing the chances of tension with the government when it eventually moves to tighten monetary policy, former BOE Deputy Governor Charles Bean told MNI.

Bean, now a leading figure at the Office for Budget Responsibility, is not convinced the Bank's GBP150 billion increase in QE in November was justified and said he regretted the Bank had not taken the chance to run down its stock of assets before the Covid pandemic struck.

While Bean applauded the Bank's move to step in as "market maker of last resort" in March, which avoided what could have been a "really serious financial crisis superimposed on top of the pandemic," he said in an interview that that logic does not support November's increase.

Monetary policy typically works by helping to close the output gap, but OBR analysis indicates that this was not forced wider by the Covid pandemic, which has instead hit supply and demand simultaneously.

GUT REACTION

"I actually think that there is something the Bank haven't got analytically correct. There seems to be a little bit of a gut reaction (from) the MPC 'Oh, activity has collapsed we must apply more monetary stimulus,'" Bean said.

"The collapse in output we think is basically a supply effect that is driven by the restrictions. And it is only as the restrictions are withdrawn a small output gap opens up which is amenable to normal monetary policy responses," he said.

With November's increase taking its asset stock target to GBP895 billion, the BOE is helping to finance the government's ballooning crisis-fuelled deficit while but also increasing the interest rate sensitivity of public finances, making a future rate hike trickier for the Bank.

The OBR forecast that debt interest would decline compared to March by GBP11 billion in 2020-21 and GBP20.2 billion in 2021-22. But the sensitivity of interest payments to a 1 percentage point rise in short rates has doubled.

"If half of the debt is at floating rate instead of a quarter, which is where we were at the time of the financial crisis, then you have doubled the sensitivity to Bank Rate. It really is as simple as that," Bean said.

This heightened sensitivity risks putting the Bank at odds with the government when at some point it wants to hike, he warned.

"There is scope for tension here … financing the deficit, it could come back to bite them in the future if rates have to rise," he said.

Before leaving the Bank in 2014 Bean made the case to "stop reinvesting maturing gilts, organic run-off as it is sometimes called, before we started active sales." But he was in the minority and under Mark Carney's governorship there was no QE unwind.

"It would have been useful to show that the Asset Purchase Facility can contract in size as well as rise in size," Bean said.

The tide may be turning, however, towards earlier QE unwind, with new Governor Andrew Bailey publicly, in a Jackson Hole speech, floating the idea of reducing asset stocks before hiking Bank Rate.