MNI INSIGHT: BOE Review To Mull Automatic Tightening Strategy

The Bank of England's review of its strategies for tightening policy will force it to examine questions about the longer-term size of its balance sheet, and of how to communicate its strategy if it opts to unwind quantitative easing "automatically", by reducing its stock of bonds at a pre-set pace, MNI understands.

An automatic unwind would, Governor Andrew Bailey indicated to a parliamentary committee last week, avoid any suggestion that the BOE might adjust its tightening programme in response to political pressure. Such a policy setting would be "one of the natural things to do in dealing with the political economy" around tightening, he said, speaking to an enquiry into QE which also heard from former senior officials who feared the government might press the BOE to keep its debt-servicing costs down.

But if the Bank were only to set out a pace for unwinding by, for example, allowing gilts to mature without replacing them, it would face questions about the length of time for which the policy would continue and the size of the balance sheet envisaged at the end of it. It would have to decide whether to specify a long-term neutral level for the Bank's balance sheet or use a conditional formulation to reassure investors that a considerable stock of bonds would be held long term.

AMPLE RESERVES

The BOE's total asset purchase target has soared since the Covid shock, hitting GBP895 billion by November 2020 from GBP435 billion last March. In a speech in 2019, the BOE's executive director for markets, Andrew Hauser, had estimated that a "steady-state" balance sheet might be in a GBP275 to GBP375 billion range. Since then, though the Bank has learnt more about the extent of demand for reserves from non-banks, particularly when markets came under pressure early in the pandemic.

The Bank operates a policy of "ample reserves," where the scale of QE, the asset purchase target set by the MPC, is the primary driver of the quantity of the central bank reserves. That leads to another communications challenge for the BOE should it put quantitative tightening on autopilot, is that officials including Deputy Governor Ben Broadbent have stressed repeatedly that QE's policy impact is determined by the stock of bonds, rather than the pace of purchases.

While the results of the review of tightening strategies are expected within a few months, any actual tightening is still some way off. Short-sterling futures price in a 15-basis-point hike in Bank Rate to 0.25% by mid-2022 with a further 25 basis-point hike to 0.50% fully priced by mid-2023.

Bailey did not go into details in his appearance before the House of Lords' Economic Affairs Committee but automatic unwind would be compatible with either a natural run-off, a pre-set programme of sales or some mix of the two.