MNI INSIGHT: Focus On Infl'n Reports As BOE QE Unwind Evolves

By David Robinson

     LONDON (MNI) - Bank of England Monetary Policy Committee members have

repeatedly presented a facade of unanimity over their approach to quantitative

easing strategy, with detailed debate taking place in Inflation Report rounds

rather than in the minuted policy meetings. However, policymakers in past IR

rounds have expressed discordant views over some of the building blocks of the

MPC's QE strategy, Market News understands. 

     The minutes from the accompanying policy meetings, however, have focussed

on the narrower debate over how much stimulus to provide with no dissent

recorded over strategy.

     The MPC's current strategy of not unwinding QE until Bank Rate is hiked to

around 2%, a level never reached within the next five years on BOE forecasts,

looks ripe for review and past precedent suggests that the rethink will be done

in an upcoming IR round.

     The building blocks of the Bank's QE strategy are that the asset purchase

pile will be topped-up when gilts mature, that there will be no QE unwind until

Bank Rate is raised to a level from which it can be substantially cut and that

that level is around 2%.

     The MPC launched quantitative easing back in March 2009. In February 2013,

when the stock of QE had risen to stg375 billion, it faced decision time over

its approach to maturing gilts as it had to choose whether to re-invest the

stg6.6 billion cash flow from the March 2013 gilt.

     A source familiar with those discussions said that the debate over

re-investing the gilt proceeds was treated as a decision over what level of

stock of asset purchases should be factored into the conditioning assumptions

for the MPC's projections in that February IR.

     That facilitated a full discussion over QE top-up, with one dissenting view

expressed that from a political economy perspective, the pragmatic approach for

the MPC would be to allow a natural run-down of the QE stock as gilts matured.

     From the get-go there had been concerns over QE blurring fiscal policy and

monetary policy, with asset purchases indemnified by the Treasury. Letting gilts

mature would at least have started to reduce the BOE Asset Purchase Facility's

(APF) hefty share of outstanding gilt issuance.

     The dominant view at the Bank, however, was that as QE worked primarily

through stock effects reducing the stock of asset purchases by not re-investing

the proceeds of maturing gilts would entail changing the policy stance by

reducing stimulus, which would sit uneasily with any MPC decision to leave

policy on hold.

     The decision was taken to condition the IR on unchanged QE and the February

minutes simply noted that "the Committee voted unanimously that the stg6.6

billion of cash flows ... should be reinvested by the Asset Purchase Facility."

     Since then the MPC has always reinvested gilt proceeds, with the APF rising

to stg445 billion, including stg10billion in corporate bonds. The MPC's

subsequent debates over whether to raise Bank Rate before starting to unwind QE

and how high Bank Rate should go before unwind starts also took place during IR

rounds and were unveiled in the depths of the reports. 

     A box on page 41 of the May 2014 Inflation Report stated that the MPC's

"preference is to use Bank Rate as the active marginal instrument for monetary

policy" and a box on p34 of the November 2015 report said that the MPC expected

to maintain its stock of QE until Bank Rate "has reached a level from which it

can be cut materially" which it judged was "around 2%."

     IR discussions are not published and the minutes of the policy meetings

accompanying these two reports again shed no light on the internal debate around

the evolving QE stance.

     Current MPC member Ian McCafferty generated headlines when in an interview

this July he said that the MPC should consider earlier unwind of QE, adding that

"it would be remiss of us not to at least think about it."

     In a speech on October 5 McCafferty said that there were "good arguments"

for raising Bank Rate before unwinding QE and "that there is no need to consider

the unwinding process until Bank Rate has been increased several times" but he

did not reassert the 2% level.

     The MPC now has a host of issues to consider over its QE strategy. 

     One is whether the impact of QE unwind is likely to have a similar scale of

impact to QE tightening and whether market rate expectations, and term premia,

will shift as a result of the announcement of any change in the Bank's approach

to QE. The very subdued response of markets to the US Federal Reserves launch of

QE unwind seems encouraging. 

     "It is most likely that the effects on the economy of asset sales will not

simply be the reverse of asset purchases. The transmission channels and the

multipliers on the way out are unlikely to be equal and opposite to those on the

way in," McCafferty said.

     Markets are a lot less dysfunctional than they were when the MPC pumped in

much of its QE stimulus and the signalling channel, under which QE was viewed as

a replacement rate cut, should be less pronounced when the asset purchase pile

is being reduced. An IR round will allow the MPC to explore all of this

in-depth.

     "There is more research to be done to understand how the economy is likely

to react to the unwind, when it comes," McCafferty said.

     While the MPC could delay any review of its QE approach until deep into

next year or later, its members are under pressure right now to justify the

current strategy which implies no unwind for the foreseeable future.

     Responsibility for QE unwind is part of the remit of new Deputy Governor

David Ramsden. His confirmation hearing with the Treasury Select Committee is

set to take place on Tuesday at 0815GMT and as an accompanying Market News

report says ( goo.gl/6YkUNZ ) TSC members plan to question him about QE.

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

--MNI London Bureau; +44 203 865 3809; email: kieran.williams@marketnews.com

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

[TOPICS: M$B$$$,M$E$$$,MT$$$$,MX$$$$,M$$BE$]