As the FT has reported this morning, the Bank of England is not just planning interest rate rises - very soon - it is also planning to begin the unwinding of its £875 billion quantitative easing programme.https://www.ft.com/content/989527cc-f056-41bb-a10c-00095ab8ec85
Unwinding QE is relatively easy. Using QE the Bank buys gilts issued by the Treasury. All gilts are issued for fixed periods varying from only a couple of years to up to 50 years. Because technically the gilts the Bank buys aren't cancelled - because the Treasury and Bank like to play a game of make believe that suggests that the Bank of a England is independent of the government - the gilts it owns eventuality come to the end of their lives. When that happens the Treasury repays the sum borrowed, including to the Bank of England.
The reality is that the Treasury pays for the redemption of the old gilt by issuing new gilts. In effect, they ask the markets for the money they have redeemed back. And to date the Bank of England had gone along with this. It has always reinvested the proceeds of any redemption in alternative gilts that it has repurchased from the money markets. The QE process has been pretty much uninterrupted by redemptions in that case.
However, hints are being given that this is to change. Andrew Bailey, the Governor of the Bank, wants to reduce the size of its QE debt holding, and next March it so happens that £28 billion of the debt it owns will come up for redemption. That is, by chance, the biggest monthly redemption there has ever been. In the 18 months that follow there will only be £9 billion of redemptions to give some indication of the scale of the event that month. And Andrew Bailey is threatening to take the redemption money, and keep it.
This is serious. That's for four reasons.
First, by next spring it will be apparent that the UK is likely following the US into recession. Stripping money out of the economy, which this will do will, will greatly exacerbate this.
Second, interest rate increases will by then already be exacerbating this.
Third, business will be crying out for liquidity by next spring as Covid debts begun to crush private sector balance sheets. Having to fund £28 billion of gilts may increase pressure on these companies, not least by creating very deliberate upward pressure on interest rates.
Fourth, we need investment for a green new deal, not to cut the size of the Bank of England balance sheet.
In that case what Bailey is doing is planning to strip a massive sum out of the UK economy at a time when it will be struggling. There is no reason to do that. The value of QE bond holdings could be left untouched. But rumour has it that is not what he wants. In an exercise about as blatant as is the middle-aged man purchase of a large motor cycle, he wants to prove his virility by sucking money out of the economy just because he can.
It takes effort to create a wholly unnecessary recession. The government is doing all it can to achieve this goal. But Bailey is right there beside them planning to do all he can too.
You simply cannot make up incompetence on this scale.
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‘Incompetence’ ?
You are being very kind.
I always thought of you as a better human being than me, because that not what I would call it.
The 10 year UK CPI inflation swap (a product to hedge CPI risk for next 10 years) has been rising continually since last year, and is now higher than at any time in last 17 years.
With interest rates at near zero, and the money base expanded due to QE, isn’t this suggesting that persistant inflation is something to at least think about? I can’t help but feel quite worried.
I see no risk of persistent inflation
Loom at the data – there is no sign of anything but short term supply issues
Literally nothing else
And the economy is heading for downturn
The last thing we need is rate rises
Persistent inflation IS certainly something to think about…. it never hurts to think.
I don’t have precise data but inflation swaps rates have been rising – I think 10 year implied inflation rates are about 4% at present. Does that represent what we think inflation will be over the next 10 years? No, I don’t think so. It is the price to hedge the risk and almost certainly overstates expectations for two reasons (a) there are few natural sellers – just the government and perhaps a few utility companies (b) the risks are asymmetric.
Also the curve is inverted with swap rates in longer maturities being lower. 10 years are at 4%, 30 years at 3%. This means that the market “expects” inflation over the 20 year period starting in 10 years time is about 2.5% (ie. 4% for 10 years plus 2.5% for the next 20 years gives 3% for 30 years).
In short, the market is not telling us that it is afraid of inflation in the long run.
Precisely
Bizarre. Everyone agrees (including Mr. Bailey) that raising rates will not deliver more HGV drivers, cut gas prices or cut container shipping costs etc.. Higher rates probably WILL cut inflation by putting many businesses to the sword and reducing prices of other things we buy (after all, inflation is an average across all prices). What a cruel way to run an economy.
As I have said before, it IS possible that inflation spends a while above target but that this is not a disaster. Recession or depression from our current state would be a disaster for many people.
I do (just) accept that other views on the dangers of inflation are possible…. but what really IS ridiculous is to push on both fronts at once (rising rates and cutting QE) at a time of such uncertainty.
Having said that, if we want to rank stupidity of economic policy it is Austerity that is way out ahead of any tinkering with rates and QE.
Is the BoE account consolidated within the Whole of Governmet Account, if so the transactions cancel out.
If not why is the basic accounting principle of control ignored by the entire financial sector when it comes to public sectoraccounting?
Is Bailey operating independently of any democratic control?
No one seems to get consolidation re the BoE
I am sure Bailey is hand in glove with what the Chancellor wants
Please don’t post my ignorance, but, you say “Second, interest rate cuts..” A typo, or do I really not follow?
Thanks
The problem of editing in a hurry and not seeing all the consequences through….
Corrected now
So, it’s disaster capitalism all over again, orchestrated by people who will not be touched by the consequences, on behalf of others who will profit by it.
You previously told us (on many occasions) that QE would never be unwound!
I never said it could not be
Because it us so unwise I said it should not be
That remains my view
I expect it will increase still, over time
you also suggested long dated gilts were a good investment proposition..this is after they were massively inflated because of QE..prices hit ludicrous levels..and have been a disaster for anyone who followed your lead
A short term view on long term issues is always a mistake
QE will never be unwound.
I asked the BOE many years ago when the QE purchases would be sterilised & they told me… “Never”.
QE has pumped the largest asset bubble the world has ever seen.
Any tapering, any rate rises, will cause a market correction the likes of which God himself has never seen.
Only a total idiot would pop the largest asset bubble ever created.
Unless….
Lets imagine you’re a bank. You are awash with cash. If you could surreptitiously unload your equities, etc then you would be positioned for a very handsome payday if, say, someone at the central bank could be convinced, with the appropriate inducements, to pop the Everything Bubble.
If you lay out a big table with the plumpest joints of meat on it, you will attract predators.
The Everything Bubble is the mother of all Smorgasbords for anyone with the clout to cause it’s collapse.
The banks have been getting thin gruel for nearly a decade and they are hungry.
This logic does make sense
Banks face inflation when overloaded with cash
I just read an article in the Evening Standard that reports that “Banks say financing loans is already more expensive due to the City expectations that rates are going up”.
This is puzzling, since as we know from the explainer on the Bank of England website, commercial banks create the money for loans and mortgages out of thin air by pressing a few keys on a computer, so why do they think they need to look for financing?
They don’t
They have cash coming out of their ears
And they create all they lend
But they also want to profit out of any opportunity
My understanding is that in QE, the BOE buys existing Gilts (held mainly by banks).
At that point, these Gilts are redeemed and should no longer exist.
But, the BOE warehouses them on its books in some sort of charade.
When the Gilts reach maturity (which they can’t because they’re already redeemed), the Gilts really cease to exist. Poof! Gone.
There is no money to exchange when they mature in the hands of the BOE.
Yes, they’re issued by Treasury & the BOE owns them but Treasury owns the BOE so…
How is this ‘taking money out the economy’ ?
The money was in fact added to the economy when the Gilts were bought by the BOE (redeemed).
But not a net add as all that’s happening is that savers money is being returned to them.
No? Yes?
Functionally gifts are cancelled on repurchase
But the BoE and a treasury pretend not
As a result there is money due in maturity, like it or not
So what I say is correct. Money might be taken out of the economy to reduce BoE debt
Lets do a worked example…
I have £100, I buy a £100, 1 year Gilt.
The BOE buys my Gilt after 2 months. I get my £100 back.
So the real economy is up £100 (for 10 months) over what it would have had if QE hadn’t happened.
BOE then warehouse the Gilt until it matures. When it matures there is no net transfer of money from a WOGA perspective.
There may be some Treasury/BOE accounting hookey pookey but none of that affects the real economy.
It got its £100 back 10 months ago.
How many £Bn in Gilts which the BOE own & choose to allow to mature (or not) has no effect on the money in the real economy.
The real action happens when I buy the Gilt and when I sell it back. After that all other transactions with that Gilts are an accounting fiction. It should have ceased to exist when I sold it back.
In my opinion….
But you ignore that HMT will seek £100 from the real economy to repay BoE
Money supply is being reduced
That is the aim
Hang on…
Government sells a gilt for £100. I buy it for £100. Government buys it back for £100.
That’s a net zero transaction.
Even if you split “Government” into HMT & the BOE, its still a net zero transaction.
HMT may ‘want’ to sell more Gilts (offer the private sector a savings opportunity) but no one needs take them up on that offer.
They would have to make it attractive, which they can’t.
You are describing the transactions you want to think happen, not those that will
You are right to lump the BoE and HMT (acting through the DMO) together – they are all “government”.
They add money to the system by government spending and/or buying gilts (from the private sector). They drain money by taxing and/or selling gilts (to the private sector).
Government to government transactions are just a charade. Private/private sector transactions do not add or drain money from the economy.
Private/Government transactions do add/drain. Up to this point, I have merely stated simple obvious truths (despite what some may have you believe)…. only now does the interesting bit start!
How much do we add/drain. Do we do it through tax/spending choices? Or through buy/sell gilts to/from the private sector? Which taxes? What spending? Add/drain through gilts sales/purchases in which maturities and at what interest rates? and more…..
This is where the debate should be happening, not quibbling about is the BoE “independent” etc.