MNI INTERVIEW: BOE Gilt Sales Should Be Slow, Steady - Forbes

The Bank of England could signal that it will reduce its balance sheet as much as possible without undermining the financial system when it announces its new framework for selling off its holdings of gilts alongside the August Monetary Policy Report, former Monetary Policy Committee member Kristin Forbes told MNI.

Gilt sales should start slowly, said Forbes, though she added that are no set rules for balance sheet shrinkage, with central banks facing a trade-off between providing guidance and leaving themselves the flexibility to adapt to changing circumstances.

“A framework could include the principle that gilt sales would cease when the BoE had reduced its reserve holdings to a level consistent with supporting the functioning of the financial system,” Forbes, a professor at the MIT Sloan School of Management, said in an email interview.

OPTIMAL LEVEL HARD TO DETERMINE

While the idea of shrinking reserve holdings to the level required by the financial system is one that chimes with thinking at the Bank, this level cannot be known in advance with any precision and could change over time, given that it will vary depending on the relative rates of return for other high quality liquid assets, as pointed out by Andrew Hauser, the BOE’s Executive Director, Markets, in a speech last September.

In 2019, the BOE estimated banks’ aggregate preferred minimum reserve range at GBP150-250 billion, which would involve vast shrinkage, as the Bank’s current asset portfolio, with matching reserves, is GBP867 billion.

“At this stage, given the uncertainty about the impact of sales (and even of unwinding the balance sheet), combined with uncertainty about what the optimal level of reserves is in the medium-term, it makes sense to establish general criteria rather than be too specific,” Forbes said.

“As the program evolves and the BOE learns more about these relationships, however, there may be a time where it would be useful to be more specific. For example, if the BOE successfully unwound a large portion of its balance sheet, it could offer more guidance on how it would be assessing when it had reached its optimal “end point” of reserve holdings,” she added.

BACKGROUND SALES

Forbes’ view is that gilt sales should carry on through market ups and downs, acting as a complement to rather than a substitute for changes in the policy rate.

“The goal is to have any sales in the background and not adopt a stop-start approach that depends on modest market movements. Since the BOE has not previously sold assets outright, and is only at the early stages of an automatic unwind, it would also make sense to start slowly and cautiously, with room to adjust, as they learn about the effects on asset market,” she said.

The BOE had earlier indicated that it would consider gilt sales once Bank Rate reached 1%, but, when this milestone was reached earlier in May it said that would report back in August.

While Governor Andrew Bailey has said that the Bank will not sell gilts in stressed markets, Forbes noted that this is not the same as halting sales because of price changes.

“Another principle could be that the pace of sales would be reduced, or stopped outright, in a period of market disruption (where market disruption is not simply a decline in asset prices),” she said.

In recent evidence to the Treasury Select Committee, Forbes praised the BOE for moving ahead of other central banks in starting balance sheet shrinkage, through natural run-off, but urged to keep going.

While the effects of doing gilt sales could be modest “it gets the Bank of England out of the business of owning a large share of government assets,” she told the lawmakers.