Quitting QE may be harder than the Bank of England believes

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Bank of England updates

After more than a decade of quantitative easing, the Bank of England will soon have almost £900bn of government bonds on its hands. The central bank last week offered the first detailed plan of how it aims to get rid of them, as it gradually tightens monetary policy following the Covid-19 pandemic.

It made the process sound positively serene. Once interest rates have climbed to 0.5 per cent, the BoE will stop reinvesting the proceeds of maturing bonds that it owns — leading to a steady depletion of its holdings. When rates reach 1 per cent, Threadneedle Street will consider selling some of its gilts back to the market.

The BoE’s Monetary Policy Committee was confident that reducing its stock of assets would have less impact on monetary conditions than buying them in the first place did. Governor Andrew Bailey added in his press conference that the unwinding of QE would proceed on “autopilot” along “a gradual and entirely predictable path”.

The breeziness seems odd, particularly given the market upheavals caused by the Federal Reserve’s past attempts to shrink its balance sheet, both in 2013’s “taper tantrum” and then in the Fed’s own experience of “quantitative tightening” three years ago. 

The BoE argues QE announcements in the past may have provided a “signal” about policymakers’ assessment of the economy and how they would react to it, indicating to markets that interest rates would stay low for longer. By contrast, announcements of the reduction of the stock of purchases would contain no such signal, the BoE said.

There are two big problems with this claim. First, the BoE also said that quantitative tightening would go ahead only “if appropriate given the economic circumstances” — making it hard to escape the conclusion that such a decision would indeed convey some signal about the economy.

The second issue is more fundamental. Central bankers are in control of what they say, but they cannot dictate what the market hears. A survey by the Financial Times this year of big investors in gilts uncovered a widespread belief that the BoE’s QE programme was a thinly veiled scheme to finance the government’s deficit, rather than an attempt to ensure the central bank met its inflation target by stimulating the economy.

If the BoE and investors are talking at cross purposes, it is no mere academic matter. The central bank’s ability to influence the economy with its monetary policy is mediated by financial markets. If borrowing costs rise, growth is likely to slow. Fluctuations in the value of the pound can have a large impact on inflation.

Decoding what the MPC is trying to achieve with QE “is like trying to understand the Enigma machine”, said Richard Barwell, head of macro research at BNP Paribas Asset Management. He argued that the committee’s members did not even seem to agree on how QE worked — so little wonder investors were confused.

Gertjan Vlieghe, an external member of the MPC, said in a speech last month that he did not expect the extra £150bn of bond purchases unveiled last November to have provided any additional stimulus to the economy: rather they were a kind of insurance policy against a return of the turmoil that struck markets at the start of the pandemic. Perhaps Vlieghe, who has departed the MPC since last week’s meeting, was being unusually frank, because this explanation appears at odds with the central bank’s previous rationale for the latest round of QE.

In any case, if policymakers wanted to reassure markets they were ready to step in if gilt prices tanked, why not just say so? Bailey has been keen to distance himself from any suggestion that the BoE is blurring the lines between fiscal and monetary policy by using QE to finance the government’s budget deficit.

But investors already believed that the MPC was practising an implicit version of the Bank of Japan’s “yield curve control” policy, in effect using its bond buying to stop gilt yields from rising rather than attempting to push them lower. 

Or if the extra QE was meant to tell investors something about the future path of interest rates, providing direct guidance would surely be simpler. Instead, the MPC opted for what Barwell called “probably the most expensive signal in the history of monetary policy”, and one that markets struggled to parse.

Putting the QE juggernaut into reverse was always likely to be fraught. But the BoE’s approach risks adding an extra layer of complexity to the process, which could have a much bigger market impact than Bailey and his colleagues anticipated, according to Mark Dowding, chief investment officer at BlueBay Asset Management.

A report by the House of Lords economic affairs committee — which includes former governor Mervyn King — last month stated that the central bank had become “addicted” to QE. The word earned a rebuke from Bailey, who said it had a “very damaging meaning for many people who are suffering”. But whether or not the BoE is addicted, it is rash to pretend that quitting will be straightforward.

tommy.stubbington@ft.com

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