MNI INTERVIEW2: QT May Affect BOE Rate Decisions-NIESR

Bank of England bond sales may push up on longer-term yields, potentially affecting policymakers’ calculations as they decide how far to raise interest rates, a new deputy director at the National Institute of Economic and Social Research told MNI.

While quantitative tightening as the BOE unwinds its bond portfolio may affect monetary conditions less than the purchases during quantitative easing, it may still push yields somewhat higher, Stephen Millard, a former senior BOE research manager before moving to NIESR to take charge of macroeconomics, modelling and forecasting, said in an interview.

The BOE’s Monetary Policy Committee will be feeling its way as it reduces its asset portfolio, monitoring its impact on markets and rates pricing, Millard said.

"If there was a discernible effect then that would create an interesting question,” Millard said, adding that the first objective would be to avoid causing problems in financial markets. "Having worked that part out then I guess the MPC might have a conversation among themselves about whether they want to raise the short-term interest rate or use QT to act on longer-term interest rates or a bit of both."

EXPLANATIONS OF QE

Views vary at the Bank as to how QE worked and the likely impact of QT. Former MPC member Gertjan Vlieghe did not expect quantitative tightening to affect yield curves, arguing that QE injected liquidity and acted as a signal for the BOE’s future rate intentions at a time when it could no longer cut, but that the inverse should not hold for QT, which takes place during a period of ample liquidity and when increases in Bank Rate are more than possible.

"We will see if QT does have a discernible impact on long rates. I am not sure it will, necessarily. But if it did then there would be a very interesting question about whether you suddenly have two tools there and you might have a view as to where you want short rates to be relative to long rates, which is more powerful in terms of affecting demand," Millard said.

“QE was associated with the idea that 'I want to keep easing policy despite the fact that I can't do it with interest rates’. So, it was kind of a signal of what your intentions are …. That was the logic for QT not working as well as QE worked. But I wouldn't assume from that that it doesn't work."

ALTERNATIVE THEORY

An alternative explanation of QE, in terms of a portfolio rebalancing by private investors into riskier assets in response to central bank bond purchases, stimulating economic activity, suggests that gilt sales are more likely to push yields higher. Recent research published by the Bank has lent some support to this theory, Millard noted.

“They did find evidence for this portfolio rebalancing channel. The interesting question is whether that would be as strong going the other way. Would it work the same way going the other way or not? Theoretically there is no reason why it wouldn't," he said.

In a speech at NIESR earlier this week, MPC member Silvana Tenreyro echoed Millard’s view that the effect of QT might not be zero, though she noted that liquidity was key.

"I know that people have stressed the difference between liquidity and portfolio balancing, In the end they are the same story for me. As long as there is liquidity in the system and markets are functioning well this should have a limited effect," Tenreyro said, in response to a question from MNI.

"This is not to say zero (effect). We will be learning about that … We will be testing the waters," she said.