Yesterday brought a very significant speech by the Bank of England Deputy Governor for Markets and Banking Sir Dave ( David to his friends) Ramsden. I have given him his full title because it might make one think he has experience in this area when in fact his official CV tells us this.
Before joining the Bank, Dave was Chief Economic Adviser to the Treasury and Head of the Government Economic Service from 2007 – 2017.
So he is part of the HM Treasury reverse takeover of the Bank of England where after claiming something is independent you pack it full of the “right” people to make sure it isn’t. But for today’s purpose the relevant bit is that he has no experience of markets at all.
Previous to that he held a number of civil service roles including leading the Treasury work advising on whether the UK should join the Euro.
If we now look at a major plank of Bank of England policy for monetary expansion ( QE) and more recently contraction (QT) we see that our markets innocent really piled in.
The amount of gilts held in the Bank’s Asset Purchase Facility (APF) on behalf of the MPC reached a peak of £875 billion in early 2022 and has since fallen back to £735 billion. As a share of outstanding government debt, the share has fallen from 35% to 31%.
Perhaps it is Sir Dave’s inexperience which makes him claim the reverse below.
The Bank can track its connection to bond markets all the way back to its incorporation in 1694.
There is quite a confession here, because I do not know about you, but before I deployed over £1 trillion I would think about how I would get out of it.
Central banks globally are considering issues relating to their future balance sheet. The Bank’s balance sheet peaked at over £1 trillion in 2022,
Indeed this is a long-running point of mine as I wrote a piece in City-AM back in September 2013 suggesting that the Bank of England reduce its balance sheet by letting its QE holdings mature without refinancing. If it had done so both it and us the taxpayer would be in better shape than we are.
Quantitative Tightening
Dave starts with something revealing.
The MPC has judged that reducing the size of the APF has the important benefit of reducing the risk of a ratchet upwards in the size of the central bank balance sheet over time, if successive policy cycles encounter the effective lower bound on interest rates.
It was a bit more than a “ratchet upwards” when he and his colleagues rushed into the UK bond markets like headless chickens. But as ever the language used by central bankers is to distract more often than inform. In fact we have some unintended humour.
The Bank combines this with market intelligence gathered from a broad set of market participants on both the buy and sell sides, to monitor gilt market functioning and liquidity for any sign of disruption.
If I was the market which remember has sold to the Bank of England at the top and has been buying back at the bottom when I stopped counting my profits I would tell them things are fine too. Indeed at the prices offered of course the auctions are going well!
Our QT auctions are going well, attracting strong demand, as reflected in good cover and pricing for the Bank.
In fact the markets have persuaded him to lose even more money as they make profits from it.
In practical terms, this means that our auction sizes for shorter maturity bonds are now larger than for medium and, in turn, long maturities. This purely operational change in our approach seems to have been received well by the market, as reflected in feedback from market participants, and good participation in the re-sized auctions.
What about the future of QE and QT?
You might think that with losses accumulating on the QE programme that Dave and hos colleagues would avoid other interventions, but apparently they do not think so.
This aggregate level of reserves demanded by banks for transactional and precautionary liquidity needs forms what we call the Preferred Minimum Range of Reserves (PMRR). At some point during the unwind, the stock of reserves will eventually approach the minimum level needed by banks.
A consequence of QE that was not thought through was that it would change money markets and whilst no-one can be exactly sure the PMRR looks to be around £500 billion. But don’t worry as Sir Dave has another cunning plan.
So, in 2022 we announced the launch of the Short Term Repo (STR) to supply reserves on demand at Bank Rate against gilt collateral on a weekly basis, to ensure that market interest rates remain aligned with Bank Rate.
In fact Sir Dave has another cunning plan in the background.
Our approach to this issue differs from other central banks, notably the Federal Reserve, which aims to maintain its QE portfolio at a level that will back an ‘ample’ level of reserves.
Seeing as he US Federal Reserve is the only central bank with proper experience of a QT programme that is somewhere between brave and reckless. Plus it has led to this hint of future policy.
At the point that reserves reach the minimum desired level, banks will be able to meet their demand for reserves at Bank Rate using the Bank’s facilities, stabilising the quantity of reserves and allowing the MPC to decide to continue reducing the stock of assets held in the APF if it wanted to.
So Sir Dave drops a hint that we may see quite a bit more of QT. Then he again illustrates my point that they should have thought about an exit strategy before putting on their bond buying boots rather than now.
The decision on the future size and composition of the balance sheet is a separate issue, which we are thinking about carefully.
But then we get what Americans would call the “money shot” where the point I have emphasised below has already been noted by financial markets.
To illustrate the separation, the MPC could unwind the APF fully, if it judged necessary for policy reasons, and the level of the PMRR should not affect this judgement.
Comment
Regular readers will know that I criticised the original Bank of England QT plans as following the route “stupid, stupider and stupidest”. The latest public finances release showed how right I was and how wrong the Bank of England has been.
The borrowing of both of these sub-sectors is affected by payments totalling £44.4 billion made by central government to the BoE over the last ten months under the Asset Purchase Facility Fund (APF) indemnity agreement. This was £39.4 billion more than the £5.0 billion paid in the same period the previous year.
There were booked profits of about £120 billion so the problem is that the £80 billion left of that is disappearing fast. For those who want more detail on this area I looked at the Treasury Select Committee report into QT on the 8th of this month. But the nub of the issue is that after highlighting 0.5% and 1% as significant interest-rate levels they found themselves raising interest-rates to 5.25%. Why does that matter? They charge themselves this so using Sir Dave’s numbers they ( and really I mean we) are paying £38.6 billion a year.
Let me look at it another way.In most jobs such incompetence would have got you the sack long ago. But those in roles like at the Bank of England survive because sacking them would reveal the truth which is very embarrassing.
We can look at Sir Dave via another prism. If we look back to July 2021 he was facing the biggest decision of his career and how historians will view him and he dropped the ball.
The first potential scenario I foresee is broadly in line with the MPC’s “central expectation” set out in the June
minutes: that the economy will experience a temporary period of strong GDP growth and above-target CPI
inflation, after which growth eases and inflation fall back towards the 2% target
Now like his view on QT he cannot escape his past mistakes.
In terms of my thinking about the future, I am looking for more evidence about how entrenched this persistence will be and therefore about how long the current level of Bank Rate will need to be maintained.
Back then he thought 4% inflation could be dealt with via a 0.1% interest-rate. Now with it 4% and falling he thinks 5.25% is correct. About sums him up really……