MNI INTERVIEW: BOE To Run QE Gilts Down To Zero - Saunders

The Bank of England looks set to press ahead with active gilt sales and to reduce its stock of bonds bought during quantitative easing to zero or near zero, two-term former Monetary Policy Committee member Michael Saunders told MNI.

While the Bank is reducing the stock of gilts held in its Asset Purchase Facility by GBP100 billion this year via an even split of active gilt sales and redemptions, meeting bank demand for reserves via its Short Term Repo facility, it has not yet specified its end-goal, Saunders, now at Oxford Economics, said in an interview.

It is possible, when the MPC is due to set out its plans for APF reduction for the following 12 months in September, that the Bank will "commit more strongly to the eventual strategy of APF to zero, with STR as the reserve (provider)," Saunders said, though he added that this confirmation could come later.

"They haven't yet put out ... [an] official Bank of England MPC statement that says this is where we're going to go ... It's conceivable that they will. It may be slightly too early for them to do that in September but I think they're going to have to do that in the next year."

The Bank's MAPS survey indicates that Market participants think it will slow the pace of APF reduction and allow active sales to wither, but Saunders reckons this is a misreading of the BOE’s intentions. In a recent speech, Governor Andrew Bailey outlined the Bank's broad strategy, under which it could continue to shrink the APF below banks' desired level, the Preferred Minimum Range of Reserves.

"I thought Andrew's speech was a very gentle pushback against the MAPS survey ...but maybe the first of several steps," Saunders said.

SOME SLOWING IN SALES IN SEPTEMBER

September’s announcement poses a tricky communications challenge for the Bank, given that the very heavy redemptions in the coming months mean that it would only be able to conduct minimal active sales if it were to continue APF shrinkage at GBP100 billion, which could be misread as a desire to end them. Saunders reckons a plausible compromise would be for active sales to slow from GBP50 billion this year but for the total APF run-down to accelerate.

"The rise in redemptions is so large that if they keep APF run down at GBP100 [billion] then active sales are only like 13 [billion] or so. So they may be tempted to raise the APF rundown target a bit, maybe not enough to maintain the current pace of active sales, but enough to prevent a really sharp drop in it," Saunders said.

Maintaining the current pace of sales would push APF shrinkage up to around GBP130 billion, so the MPC could settle on something like GBP115 billion, cutting active sales to GBP30 billion. That would be "an easy way to get a slightly faster APF rundown, easy in the sense that you're not having to do more active sales in order to achieve it," according to Saunders.

One concern for the Bank is that as it shrinks the APF it could spark market turbulence when trying to meet reserve demand via the STR but Saunders stresses that this would be something for the Bank to fix rather than something that would necessarily derail the zero APF strategy. (See MNI INTERVIEW: BOE Could Spark QT Woes Before Banks Expect)

It would take a sustained market reaction to make the BOE rethink its approach, he said.

If the feedback from markets is "that there's a fundamental problem with this strategy of an STR-backed reserve system, then at that point, the Executive Board and the market team would say to the MPC, 'look, given that, we think we've got to have a rethink as to what the appropriate pace of QT is for the next year.’ And the MPC would ... go along with that, because they don't really have any superior knowledge," Saunders said,.

But "the hurdles are that it has got to be persistent, and there's got to be something which the markets team and Bank Executive can't overcome just by tweaking something in the STR," he said.