The Bank of England’s balancing act | USAEMALL.com

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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

Not a great start:

This morning’s speech by the Bank of England’s Victoria, uh, Saporta was exciting for reasons that are mainly technical: as regular readers will know, FT Alphaville is unusually interested in UK quantitative tightening, and it’s been a heady few weeks for talk about balance-sheet reduction.

Nobody, as far as we can see, actually expects quantitative tightening to stop.

The BoE wants to reduce the size of its balance sheet, and allowing the roll-off of maturing gilts held in the Asset Purchase Facility — the vehicle through which quantitative easing was conducted — is the simplest way to do it.

Indeed, it’s also the most neutral action, since replacing gilts as they mature would entail renewed bond purchases. The natural path is QT. The (rising) area of debate is over active sales — the pace at which the BoE, uh, actively sells gilts in order to whittle the power down more quickly.

The pace of active sales is ostensibly set by the Monetary Policy Committee, but there’s always been an feeling of kabuki to these decisions.

Last year, the Treasury select committee labelled QT a “leap in the dark”, which is somewhat true: the BoE is clearly making things up as it goes along. But it’s more of a shuffle in the dark than a leap. Alongside the process of balance sheet reduction, we’ve had regular updates from the BoE’s markets wing to the effect of “another step taken, still haven’t stubbed our toe”.

The implication of this — emphasised by the BoE being forced to delay a gilt sale in the post-Liberation Day febricity — is that the MPC makes QT decisions at the pleasure of the BoE’s markets and financial stability functions.

If those authorities said they were seeing substantial risks from active sales — say, that sales were causing major, persistent disruption in long-end auctions — then the MPC’s hand would surely be forced. As we mentioned earlier this week, that is inevitable in part because so many MPC members are conflicted by wearing multiple hats.

That dynamic was driven home recently by Sarah Breeden — deputy governor for financial stability — telling MPs that a long-end yield increase “does not much matter from a monetary policy perspective” (more on that in Chris Giles’s latest newsletter). Clearly they do matter from a financial stability perspective — but will Breeden just ignore that when she casts her MPC vote?

Fittingly, Saporta’s speech is titled “Learning by doing”, and it appears to confirm that — for now — the MPC remains in control. The effective veto that is held by other parts of the BoE has not been deployed, yet.

Picking up where the Bank Overground left things last week, it represents the BoE saying “repo is coming, gird your loins” to any and all users of its reserves system. (It is accompanied by a statement analysing feedback to the planned move to repo, which also basically says “here we go”).*

Saporta:

[We] will continue to learn as the liquidity environment changes, including how market liquidity conditions – particularly in liquidity and funding markets – evolve. As conditions evolve, so too will the Bank’s approach. Change won’t happen overnight – we fully appreciate the value of certainty and planning. But it would be surprising if we hadn’t reflected on the precise calibration of our facilities in, say, a few years’ time. Any changes would be clearly signalled to the market: we will continue to update our framework in a gradual and predictable way, ensuring that the liquidity of sterling markets supports our objectives of monetary and financial stability…

By engaging actively, planning thoughtfully, and being adaptive to change, firms support a smooth transition to a repo-led framework. That means that SMF firms must now fully consider the changing liquidity environment, and their plans to source reserves within that.

Plenty of uncertainty from both a market operations and MPC voting perspective, and a frisson-inducing hint at future ruptures: it’s the most positive outcome. For us.

*This part of the statement caught our eye:

Some respondents asked for the [short-term repo] to be indexed to Bank Rate so that the bidding window for the operation can be moved to the usual time of 10am on the days of the Monetary Policy Committee (MPC) announcement. The bidding window for the STR opens on Thursdays at 10am except for the Thursdays on which the MPC announcement is made, when it opens at 12.30pm.

The STR is indexed to Bank Rate but at the time of launching the facility the Bank judged that certainty of the rate at which reserves are being supplied (ie by holding the STR after the MPC announcement) would make the facility more predictable to firms. The Bank acknowledges the feedback and will consider making a change in due course.

As usual, we have nothing intelligent to add but it’s at least interesting that this could seemingly create a live market in STR around Bank Rate decisions. We’d assume that less predictable = more profitable for… someone. Let us know if we’re missing something obvious here.