London — The Bank of England is taking a risk by highlighting an exit strategy from its pandemic bond-buying programme even before the UK has emerged from lockdown. If the economy fails to pick up, the bank could be forced into an embarrassing U-turn.
Governor Andrew Bailey indicated on Monday that he might reduce the BOE’s swollen reserves before hiking interest rates, in what would be a reversal of the course set by his predecessor Mark Carney.
This is a double-punch for those expecting an ongoing flood of money. Just last Thursday, the bank’s monetary policy committee sent a clear message on tapering its quantitative easing (QE) programme. Now, we have what could be interpreted as forward guidance on unwinding stimulus. The overall tone suggests that last week’s £100bn increase in the Covid QE package might be the last.
For a central banker in febrile times, these are bold signals. The US Federal Reserve is the only major central bank to properly attempt to exit monetary stimulus since the global financial crisis. It raised interest rates several times before attempting to reduce its balance sheet. Bailey would reverse that order.
Even before the pandemic hit, the Fed had to cut rates aggressively again — under no small pressure from President Donald Trump — and rebuild its balance sheet by 70% because of a weakening economy. So there’s some logic to Bailey thinking about a different unwinding strategy.
However, talking about selling assets when still buying them might undermine the impact of the UK’s pandemic QE programme before it has had time to work properly. Lower long-term bond yields take a while to get through to the real economy. If investors start to steel themselves for fewer purchases, as well as actual disposals in the foreseeable future, that might push up rates on longer-maturity gilts, somewhat defeating the original purpose of QE.
This messaging is in stark contrast to other major central banks. The European Central Bank has just hugely increased its provision of liquidity to lenders and its bond buying, whereas the Fed has been snapping up corporate debt for the first time — including some junk bonds. In fairness, the UK government’s fiscal response has also been substantial, and will probably be increased, so the central bank’s monetary actions have to be looked at in tandem with that.
Bailey is also signalling that official interest rates will stay close to zero for several years, as raising rates will take a back seat to cutting leverage in the financial system. His comments reduce the likelihood of Britain trying more unconventional monetary experiments such as negative rates.
Former BOE policymaker Andrew Sentance said in a tweet that he thinks Bailey’s intervention is an attempt to ease the pressure for sub-zero rates, a favoured tool at the ECB and elsewhere.
The BOE can always increase QE again if it needs to, but that might damage its reputation for economic management. Understandably, the bank does not want to be in the perilous position of the ECB, which has repeatedly stretched all of its resources to deal with consecutive crises. But there might have been some merit in waiting for the UK to show sustained signs of recovery before talking about snatching away the punch bowl.