Bank of England leaps $100 billion into the unknown

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Central banks are about to start withdrawing the stimulus they injected into their economies by buying bonds. For the Bank of England in particular, shrinking its balance sheet while simultaneously raising interest rates takes monetary policy into uncharted territory. Policymakers could quickly find themselves in the crosshairs, blamed for exacerbating the economic downturn they have predicted.

The UK central bank, already well into its cycle of raising interest rates, is set to accelerate the contraction of its £863 billion ($1.04 trillion) quantitative easing portfolio. In March, it stopped reinvesting maturing debt; after his September 15 policy meeting, he plans to start selling gilts on the secondary market. The problem is that because the last 13 years have only seen more and more QE, first as a result of the global financial crisis and then to sustain growth during the pandemic, no one knows the impact economic of removing £80bn – close to $100bn – of central bank liquidity a year.

The BOE has taken great care to distinguish between its main monetary policy tool, interest rates, and this additional measure of so-called quantitative tightening. Although he says he doesn’t expect QT to have much influence on monetary conditions, these are really just guesses. If liquidity in the banking system runs out, it could very easily turn into political football.

These are dangerous waters: the first two attempts at QT by the Federal Reserve had to be stopped and, ultimately, canceled. It remains to be seen how far the BOE can shrink its balance sheet without causing a crisis in the bond market, as the Fed also tries to shed $95 billion a month from its $9 trillion balance sheet. One thing is certain, it has proven impossible to get central bankers to quantify the effect of the unwinding of their bond holdings, in terms equivalent to a change in official interest rates.

The most specific QE calculation came from former BOE Governor Mark Carney. In a January 2020 speech, he said the central bank estimated that every £25 billion bond purchase had the same effect as 25 basis points of a rate cut. Fed Chairman Jerome Powell in his May 4 press conference estimated that $1 trillion of QT is equivalent to a single rate hike of 25 basis points. This disparity says a lot about the slipperiness of the prognosis.

The BOE will also dispose of its £19bn of corporate bonds by April 2024. This may seem small compared to the enormity of the BOE’s gilt holdings, but it could cause aftershocks in the market. high-quality sterling credit, as this is equivalent to two-thirds of the annual volume of new corporate issuance. This could certainly cause credit spreads to widen and hamper potential issuers if they compete with the central bank for investor demand.

BOE Governor Andrew Bailey has made it clear that the central bank intends to maintain a sizeable bond portfolio, likely on the scale of the £450bn it held before the emergency bailout. pandemic. Buybacks will reduce the QE pot by around £240bn by 2026, with active sales of £160bn easily completing the task. Further reduction in the BOE’s balance sheet will come from the expiration of pandemic support provided directly to banks and businesses, with the bulk of around £192bn from the term funding scheme running out during of the next three years. The liquidity of the banking system will have to be managed with caution.

The Monetary Policy Committee has said planned divestments in bonds can be paused during times of market stress, but Deputy Governor Dave Ramsden said this week there was a ‘high bar’ to halt selling even if the BOE changed direction on interest rates and began to reduce borrowing costs. . More than a decade of ever-growing death tolls suggest that could turn out to be wishful thinking.

Anything could go well, with the market absorbing the additional supply of gilts and the financial sector dealing with reduced liquidity. But the steady reliance on monetary largesse in recent years gives little incentive to believe that Britain’s already struggling economy can weather the twin headwinds of withdrawal of stimulus and rising borrowing costs. As the old cards said, Here Be Dragons.

More from Bloomberg Opinion:

BOE’s doomsday prophecies fall on deaf ears: Marcus Ashworth

The Pros and Cons of Liz Truss: Adrian Wooldridge

• The global economic outlook is as clear as mud: Mark Gilbert

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Previously, he was Chief Market Strategist for Haitong Securities in London.

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