MNI INSIGHT: Functioning Market Allows BOE Gilt Buying Exit

The Bank of England's buying of long-dated UK gilts looks set to end as scheduled on Oct 14 as debt markets return to relative calm with yields higher than in the days leading up to the bout of undefined “dysfunction” which prompted the announcement of emergency purchases on Sept 28, but no sign that such extreme conditions persist.

While the Bank sprung into action to protect over-exposed pension funds during last month’s sharp sell-off, not only postponing plans for active gilt sales until Oct 31 but promising to buy debt, it has avoided providing any precise definition of the “dysfunction” which it said threatened financial stability.

Its operation, designed to give pension funds time to order their affairs as yields ramped higher amid concerns over unfunded government borrowing, focuses on defusing margin-call-fuelled price spirals. It is not, in contrast to the yield curve control practiced by other central banks, intended to protect particular price levels, despite some speculation that the BOE was worried by UK 30-year bonds breaching 4%.

This tactical ambiguity allows room for some subjectivity in the Bank’s judgements, but it seems clear that current market conditions are not dysfunctional in any obvious sense, and should therefore permit the commencement of active gilt sales later in the month, after purchases have concluded. Assuming relative calm persists.

TACTICAL AMBIGUITY

As former BOE Monetary Policy Committee member and New York Fed adviser Kristin Forbes has said in an MNI interview, being too precise about the Bank’s market operations can backfire by providing targets for speculators. A concrete pricing threshold could “create distortions if certain activities are subject to a central bank put, while others aren't,” and also cause panic if the level is approached, she noted. (see MNI INTERVIEW: QE Rules Should Be Clearer - Forbes).

So far this approach has worked, and the Bank’s rescue operation has been relatively cheap, possibly even turning a profit when the gilts are resold. While the BOE has been ready to purchase up to GBP5 billion of long-dated gilts in each auction, in practice it has bought considerably less and even rejected large numbers of bids.

So the way would seem to be clear for the BOE to reduce its stock of assets and to start sales, as long championed by Governor Andrew Bailey.

The turbulence in the long-dated gilts market following the government’s Sept 23 mini-budget should only influence monetary policy insofar as it shows up in the asset prices which feed into its November forecast round and are reflected in the Bank's Monetary Conditions Index. The Monetary Policy Committee will also, ideally, be able to conduct a full appraisal of the new approach to fiscal policy at its meeting next month.

BOE Chief Economist Huw Pill has said that it was likely that "the fiscal easing announced last week will prompt a significant and necessary monetary policy response in November." While the mini-budget gave only half the fiscal picture, announcing just the giveaways, it now appears likely that the complete budget, originally set for Nov. 23, will be brought forward to late October, allowing the BOE to consider the full fiscal picture as it makes its next policy decision.