MNI INTERVIEW: Strong Case For BOE Gilt Sales At 1%-NIESR

The Bank of England is likely to launch into active gilt sales as soon as Bank Rate reaches 1% but is unlikely to allow the Debt Management Office to run the process, a new deputy director at the National Institute of Economic and Social Research told MNI, arguing that there is a strong case for the BOE to reduce the size of its balance sheet.

The BOE’s guidance allows for it to decide whether to sell gilts “depending on economic circumstances” when Bank Rate, currently at 0.5%, hits 1%, but Stephen Millard, a former senior BOE research manager before moving to NIESR to take charge of macroeconomics, modelling and forecasting, said there should be no reason for delay once the threshold is reached, assuming markets are not stressed.

"As long as there wouldn't be any adverse financial market reaction I am sure that they will do it," Millard said in an interview

The BOE, which has talked extensively with representatives of commercial banks, has a clear incentive to reduce its balance sheet, he said.

BANKS HAVE TOO MANY RESERVES

“It is fairly clear that the Bank of England's balance sheet needs to shrink … because on the other side banks are being forced to hold a lot of reserves. They are holding much more in terms of reserves than they would want to,” Millard said.

The desired level of reserves seems to be way below the GBP895 billion created through asset purchases. While the Bank’s markets head Andrew Hauser floated a GBP400 billion figure in the days before Covid, it is not clear whether the Monetary Policy Committee will reveal its view of an equilibrium point for reserves, or whether it will just announce near-term sales plans.

"That is a very difficult question. My gut feeling, as always, is that you should absolutely be transparent. in what you are doing. So, if you have a figure in mind then say what that figure is. If you are very uncertain about what that figure is say you are very uncertain about what that figure is and that you will go carefully to get there," Millard said.

"Maybe the way to do this is for the MPC [to say] this level of gilt holdings is where we think the right place … is for monetary policy. We will allow our markets people and DMO to work out how quickly we get down to that,” he said. In this case, the pace of gilt sales would become “technical details that they will handle.”

But, he added: "The counter is that what they wouldn't want to do is to say 'We are going to do this amount of sales and the markets just think 'that is too much to take'."

COORDINATION

The prospect of both the Bank and the DMO seeking to sell substantial amounts of gilts into the market at the same time has led to suggestions that the BOE could allow the government to handle the process. But Millard saw anything beyond coordination as unlikely.

“I can't see that happening. You could do that, but I don't think the Bank will want to … that would look very much as if they are no longer setting monetary policy independently," Millard said.