Britain’s quantitative tightening will harm us for a protracted, very long time | USAEMALL.com

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Christopher Mahon is head of Dynamic Real Return in Multi-Asset Investing at Columbia Threadneedle Investments.

Last month, FT Alphaville published our estimates that the Bank of England’s quantitative easing programme cost over 5 per cent of GDP — around four times the cost to the Fed.

The worse financial outcome for the UK central bank can be put down to how the programme was designed: not tailored to domestic conditions (mismatched between the short term nature of UK household borrowing and the unusually long maturity of UK government debt), and carried out at a disproportionate scale and concentration. 

We pointed out that some questionable decisions continue — with the current process of quantitative tightening hurting the taxpayer further, by pushing up yield levels.

Here’s what happened since then:

• MPC member Megan Greene suggested QE should be used in a more targeted way 

• BoE Chief economist Huw Pill suggested the scale the of the historic QE programme was something of a ‘sledgehammer’

• The BoE dropped a sale of long-dated bonds

• Former MPC member Sushil Wadhwani appeared to link QT to the performance of long end yields — something the BoE itself has long resisted acknowledging

Of course, much of this is down to the intervening market turmoil and the bond markets getting in a twist. But let’s put some further grist to the mill. 

In our earlier article, we highlighted how the BoE being a large seller of gilts had pushed yields up. We put the cost to the Treasury from the higher debt servicing costs at around £1bn per year. 

But that arguably downplays the fiscal drag from QT. Every gilt issued by the Debt Management Office now competes with BoE QT driven gilt auctions and ends up costing the Government more than it might have. Remember, these are fixed-term gilts, and the cost is baked for the whole life of those bonds.

In a UK macro context, £1bn per year isn’t much. But give it time, and the costs certainly add up. Can we estimate the size of the long-term hit?

Let’s do some calculations.

Thanks to researchers at NBER we have an estimate of how much QT has affected the yields for each bond type (high-res):

We can combine those yield moves with the planned issuance of each type of gilt announced via the DMO. Taking 2025/26 issuance as an example, we can pro-rate the “unallocated” gilts, and use the NBER estimate to create a lifetime cost for one year’s issuance (high-res):

The estimates above are necessarily quite rough. The QT yield impact is key — and maybe the NBER research overplays the figures a bit. But still, even if the impact is just half of the above, it would still mean one year of the BoE QT programme equates to £9.3bn in extra debt serving costs over the lifetime of gilts issued this year. With 2.5 years of QT under our belts we could already be looking at the knock-on costs to the Treasury approaching £20bn so far. These costs are additional to the direct QE losses officially recorded by the BoE, which currently stand at £120bn.

The shadow of active QT will be with us for a long time. The BoE went from having the world’s most aggressive QE programme to the world’s most aggressive QT programme. The BoE’s record of running these programmes in a cost-effective fashion is poor — it is the unwelcome standout in terms of costs to the taxpayer among central banks.

Today, its unique approach continues. The BoE is shrinking its balance sheet faster — actively selling huge volumes of gilts — in a manner unlike other central banks.

The MPC stated there would be a “high bar” for changing course on the planned gilt auctions. But since 2023 — when I joined others in highlighting the risk of bad outcomes from the BoE’s approach to QT — the linkage between the scale of the Bank’s gilt sales and the weakness of gilt prices has become a more accepted viewpoint. 

The precautionary principle means if there is a reasonable chance that QT is hurting the taxpayers anything like the £20bn estimate we’ve reached, why wait until the annual review in September? To spare the Bank’s blushes: long-dated gilts are once again creeping towards the yield threshold that caused the BoE to postpone an auction just one month ago. Announcing a more permanent postponement could be a solution.

To avoid accusations of institutional sleepwalking and given the likely long-term pain each and every QT auction induces, the BoE should not continue on the same path even a day longer than necessary. A course change is needed.