MNI INTERVIEW: BOE Could Spark QT Woes Before Banks Expect
Paul Fisher, former BOE Executive Director Markets, talks to MNI about QT.
The Bank of England could be forced to alter its approach to quantitative tightening, including cutting active asset sales, before it has shrunk reserves to the level commercial banks say they want, a former BOE executive director of markets told MNI.
While Governor Andrew Bailey has noted that banks estimate their Preferred Minimum Range of Reserves at only GBP345-490 billion, far below the current GBP760 billion held at the Bank, Paul Fisher noted that banks are better at predicting their own, but not aggregate demand, and that liquidity stresses could flare well before these levels are reached.
“What they individually think may be the right number doesn't necessarily add up to what the system needs. And then you could have 99 out 100 banks with perfectly enough liquidity, and if one bank is short, then the market can get disturbed," said Fisher, now a professor at Warwick University.
"The first you will know is when you start to get a bit of volatility in interest rates ...[It's] the old joke about burning the toast, first until it smokes and then 30 seconds less," he said.
At its current pace of QT the Bank would hit the top of the PMRR in the second half of 2025. The Bank should monitor demand for its lending operations very carefully, Fisher said.
"When somebody starts to get short, as long as they come to you to borrow, you will start to see it first in those operations. As the level of assets goes down, the Bank will be prepared to increase their lending to offset so the system stays within the preferred range of reserves.” (See MNI INTERVIEW: Big Central Bank Balance Sheets Here To Stay)
EXECUTIVE RUNNING QT
At its September 2023 meeting, the BOE’s Monetary Policy Committee voted to reduce its stock of gilts by GBP100 billion over 12 months, split between active sales and passively allowing gilts to mature. The Bank's survey of market participants shows they now place a significant chance on a halt to active sales from September.
It is actually the Bank’s executive, rather than the MPC, which controls QT, as it has the power to alter the pace of sales, collateral requirements and institute lending schemes, noted Fisher, pointing out that it was the executive which came up with the Funding for Lending scheme which provided crucial cheap funding to banks during quantitative easing.
"The way they've framed it ... the MPC decides how much assets to buy [or sell]. But ...the Bank executive could then change the money supply by lending more or less, so it can override the effect of changing asset purchases on the quantity of money. So actually the Bank executive could independently decide the quantity of money. But there are arrangements in place to make sure that the MPC is consulted about significant changes" he said.
"There's no such thing as completely independent monetary and financial policy decisions," he said, adding that "The MPC and FPC are always briefed and agreement sought ... even if it's not their decision."
REPOS LIMITED IN SIZE
The Bank's broad approach is that once the PMRR is reached, it could continue to reduce QE-related gilt holdings while adopting a demand-led approach to reserves, delivering them to banks via repo or other operations. But Fisher said there would be a limit to the scale of repos.
"You don't want to be turning over GBP100 billion on your balance sheet every week, not in the UK. It's too big. The risk is of making a mistake - some bank getting left short, not getting money in the operations. - it's just too much,” he said, “So what you can do is structure, say, 12-months, six-months, three-months and one-month lending as well as weekly. You can keep the amount that's being turned over every week at the margin a bit lower and give more certainty to the banks about getting enough cash all the time to meet their requirements.”
The Bank could also adjust collateral requirements, though these already vary according to the different repos. As banks get shorter some may bid up to use less liquid collateral.
A recurring political question is whether the BOE should end full reserve remuneration, but Fisher said this would be on a tax on the banking system.
“If you want to tax the banking system, that's fine but you shouldn't be doing that through monetary policy arrangements,” he said.