MNI: BOE Carney: May Not Need Bank Rate At 2% For QE Unwind

--BOE Governor Lays Out To TSC Why QE Unwind Could Start Before Bank Rate At 2%

By David Robinson

     LONDON (MNI) - Bank of England Governor Mark Carney opened the door to

starting the unwinding of quantitative easing before Bank Rate is increased to

2.0%.

     In evidence to the Treasury Select Committee Tuesday, Carney said that

things had changed since the Bank offered guidance back in its November 2015

Inflation Report that it expected to maintain its stock of asset purchases until

Bank Rate rose to "around 2%."

     Carney told the TSC that ideally the MPC would raise Bank Rate from its

current 0.25% to a level where it could then cut it by 150 basis points if

needed, so that it could use rate cuts alone to deal with a typical economic

downturn rather than resorting to QE. 

     "It would be better to be in a position where you got Bank Rate up to a

level where you could run through an average interest rate cycle which, with the

exception of the drop in interest rates post the financial crisis, in this

country has been about 150 basis points on average since the advent of inflation

targeting in '93," Carney said.

     On that formulation, Bank Rate should be raised to 150 basis point above

the effective zero lower bound (ZLB) before QE unwind begins. The MPC cut Bank

Rate to 0.5% in the depths of the financial crisis but in August 2016 it lowered

it by 25 basis points to 0.25% in the wake of the vote to leave the European

Union.

     "We have shown with the August 2016 rate cut that the effective lower bound

on interest rates is a little lower than we thought it was at the time we said

that so we maybe don't have to get quite as close to 2.0% as we thought," Carney

said.

     Although the MPC cut Bank Rate to 0.25% in August 2016 members made clear

at the time that they thought that the ZLB was even lower than that.

     At that August meeting, the MPC minutes recorded that members "discussed

whether to cut Bank Rate immediately to its effective lower bound, close to but

a little above zero" or to go with a 25 point cut.

     While the MPC has never put a precise figure on the ZLB, the assumption is

that it is positive but only just, with 0.1% a plausible answer. So moving Bank

Rate up to 1.5% would almost satisfy Carney's criteria for QE unwind.

     The BOE Governor said that it was not just the estimated level of the ZLB

that had changed. The other thing the MPC is watching closely is the market

reaction, or lack of it, to QE unwind in the US.

     "The Fed is going to engage in some quantitative tightening ... and

undoubtedly we will learn from that," Carney said.

     "UK financial conditions ... are very influenced by foreign developments

particularly in the US," Carney said.

     He added that around 75% of any adjustment in term premia in the US in

response to QE unwind would likely "spill over to the gilt curve and steepen the

gilt curve."

     On current market rate expectations, Bank Rate climbs to around 1.2% over

five years, so lowering the likely level QE unwind could begin to 1.5% or below

that if the lessons from the US suggest the effects of unwind are slight, would

make unwind look a more realistic prospect. 

     Carney was asked about a recent comment from former top Treasury official

Nick Macpherson, who said that QE was like heroin, with policymakers hooked to

it and having to do it in ever larger amounts to get the same effect.

     In an acerbic response, Carney noted that Macpherson was the accounting

officer at the Treasury who signed off on the indemnity for the BOE's Asset

Purchase facility, the Bank's QE vehicle.

     Carney said that while it was true that the first wave of QE, when market

dislocation was severe, appeared to have had more effect than the second round

the third round, in August 2016, generated a bigger bang than anticipated,

suggesting the pattern of diminishing returns is not linear.

     "The QE and corporate bond package of 2016 had quite a sizeable effect on

financial conditions in this country. It is always difficult to control for

other factors in making those determinations but it does have an impact on

financial conditions. It does provide stimulus to the economy," Carney said.

     He declined to speculate on whether the Bank would have started to reduce

its stock before his term as governor comes to an end in June 2019, but insisted

it was able to do it if necessary.

     "We are clean, we are not addicted to QE. We are not going to go through

some withdrawal symptoms if the time comes and it is appropriate to gradually

reduce assets ... But we are not going to prove a point either. We are not going

to do it just for fun," he said.

--MNI London Bureau; tel: +44 203-586-2223; email: david.robinson@marketnews.com

[TOPICS: M$B$$$,M$E$$$,MC$$$$,M$$BE$]