MNI INTERVIEW: BOE To Unwind QE Before Hike-NIESR Deputy

The Bank of England looks set to reverse its previous strategy and indicate it would start unwinding quantitative easing before hiking Bank Rate, though no tightening is likely for some time yet, the National Institute of Economic and Social Research's deputy director Hande Kucuk told MNI.

Bank staff have been asked to reconsider the current tightening strategy of maintaining the stock of asset purchases until Bank Rate reaches around 1.5%. Kucuk foresees that strategy being flipped to allow asset sales first.

"If things start to go back to normal and if we are in a good recovery phase then probably what Bank of England will do is wind down first on QE, on asset purchases, before starting to raise interest rates," she said in an interview, noting how in tackling the Covid shock the BOE has used QE as its marginal policy instrument.

NIESR said in its latest quarterly review that the expansion of the Bank of England's gilt holdings, which currently stand at GBP875 billion, presents a financial risk to the public coffers, as QE is funded through central bank reserves remunerated at Bank Rate, so only if gilt rates remain lower than that is there any fiscal benefit.

Debate persists about the mechanisms by which QE operates, and "the ambiguity around its quantitative effect on the macro economy," Kucuk said, adding that nonetheless she is doubtful Bank Rate will rise enough any time soon to trigger asset sales.

"Given the slow recovery that we expect we don't see sustained pressure on inflation to make it the case that the interest rate starts rising all of a sudden," she said.

CONTINGENT FISCAL POLICY

With the March 3 Budget approaching, Kucuk said Chancellor Rishi Sunak should be explicit in making fiscal policy contingent on economic developments, with any tax hikes linked to the strength of the recovery rather than arbitrary fiscal goals.

UK public sector net debt has surged following the Covid shock, rising to 99.4% in December. NIESR estimates it will reach 108% of GDP in 2020-21 and 110% in 2021-22, but Kucuk warned against tax hikes now, noting that even confirmation that they are on the way would have a negative impact.

"We know from the academic literature that the moment you announce them, that news starts to bite on the recovery," she said.

Government moves to end job support schemes should take into account the effect of lockdowns on particular regions and sectors, she said.

"The fiscal policy actions and the rise in the debt should really be put in the context of what is happening in the economy and the damage that the pandemic has caused and the same thing for the job support schemes as well," Kucuk said.

When tax rises are introduced the preferred measures will be those with the smallest fiscal multiplier, minimising the hit to the real economy in proportion to revenue raised. Income tax increases had the lowest multiplier among standard measures, Kucuk said.

The governing Conservative Party ruled out raising the income tax rate in its manifesto but altering tax thresholds may work well, with lower income groups with high marginal propensity to consume shielded from tax increases.

"The threshold idea would work because these income tax multipliers … should be smaller for higher income households. If the thresholds for these are adjusted in such a way that the government can collect more tax revenue from high income households then this might a better way of doing this," she said.