The BOE’s gilt sales programme risks being too slow from a political perspective and too fast for markets, former top BOE official Bill Allen tells MNI.
The Bank of England will struggle to reduce its balance sheet quickly enough to reduce the danger of political interference in the next few years, but the pace of quantitative tightening will still pose difficult debt management issues in tricky markets, former top BOE official William Allen told MNI.
The BOE’s Monetary Policy Committee will vote next month on launching gilt sales of around GBP10 billion a quarter, reducing its GBP844 billion stock of gilts, when combined with redemptions, by some GBP80 billion every 12 months. While it has not specified an end point for the sales, at this pace its balance sheet would remain a potential political target for years, said Allen, who served in a variety of capacities at the Bank for three decades including deputy director until leaving in 2004. (See MNI INSIGHT: BOE's QT Pace Known, Terminal Point Unknowable)
"There is a long way to go. If you are doing GBP80 billion a year then it is going to take you perhaps five years or longer,” to make a dent in the balance sheet, he said. “And during that time you have got the exposure of the public finances to short-term interest rates. And this is a time when there is immense pressure from everybody either to cut taxes or hike government spending or preferably both. So it is going to be pretty difficult to manage.”
One temptation for government, already identified by the BOE, would be to end or curtail remuneration on the central bank reserves which were paid to banks in return for gilts bought during the years of quantitative easing.
“It's a terrible idea and it has got quite a lot of support, so it is rather worrying," Allen said, noting that the BOE’s interest payments are a form of public spending outside the direct control of parliament. “So there is a very powerful political-economy reason for shrinking the central bank balance sheet as fast as possible.”
While the slow pace of balance sheet shrinkage concerns Allen, he also worries that the sales programme may spark market volatility as it effectively competes for buyers with the Debt Management Office’s government funding programme.
“The amount of bonds you are going to be trying to stuff into the market is going to be swollen by this disgorging by the Bank of England on top of the normal sales by the DMO,” he said.
The Bank plans not to sell gilts on the same day as the DMO, and to avoid selling the same bonds at the same time. This is “perfectly sensible and coherent,” Allen said, adding that it should “work fine as long as nothing goes wrong and all the auctions are covered.”
The BOE’s balance sheet contains a high proportion of long-dated gilts with thinner liquidity, which could occasionally prompt the BOE or the DMO to call off auctions, he said.
"With the arrangement that they are going to have, there is a risk that the Bank … is going to have to make one decision and the DMO is going to have to make another decision later the same week or a different week. There are going to be two on the spot decisions … and they should be consistent otherwise there is an incoherent policy,” he said.
Allen, with colleagues at the National Institute of Economic and Social Research, proposed a deal under which commercial banks and the Treasury would swap the BOE’s long-term bonds for shorter maturity ones, but it has not been adopted, he noted.