- Bank of England deputy governor says ‘so far, so good’
- But 'quantitative tightening' is no substitute for interest rate policy
We are approaching the first anniversary of the Bank of England’s (BoE) ‘active’ quantitative tightening (QT) programme. Given that only a year ago, the BoE “had no direct evidence on how sales would affect financial markets”, things seem to have gone remarkably well.
The BoE had embarked on another significant programme of quantitative easing (QE) in response to the Covid-19 crisis and its aftermath. The stock of assets held by the Bank swelled to £895bn by the end of 2021 – £875bn of which was government debt. In February 2022, QE went into a gentle reverse as ‘passive' QT began. The Bank stopped reinvesting the proceeds from maturing bonds, allowing them to run off the balance sheet instead. In November, things went up a gear when the UK became the first country to start ‘active’ QT and the BoE began to sell bonds back to financial markets.
QE has not been reversed in scale… nor impact
The pace of QT has been gentle – and deliberately so. The BoE has expressed a commitment to keep it “in the background”, and conduct sales “in a gradual and predictable manner” so as not to disrupt the functioning of financial markets.
The BoE intends to reduce the stock of gilts held in the asset purchase facility (APF) by £80bn by the end of September 2023. Although a significant amount, it represents only a very partial winding back of QE: the Bank estimates that (including corporate bond sales), the size of the total APF will be reduced by only 11.6 per cent.
Interestingly, the impact of QT has not been a mirror image of the effects of easing. QE is thought to impact the economy via a ‘signalling channel’. Economists think that by embarking on a programme of asset purchases, central banks signal to markets that they are still in ‘expansionary mode’, and – crucially – that interest rate hikes are not on the horizon.
The BoE is now firmly in ‘contractionary mode’, yet QT does not provide the same kind of signal about where interest rates will go next. BoE deputy governor Dave Ramsden reaffirmed last week that “in line with our key principle that Bank Rate is the active tool [of monetary policy], the Monetary Policy Committee is not using QT to signal the future bath of Bank Rate and so materially change expectations of policy rates”.
But can QT substitute for higher interest rates?
Research suggests that the tightening can complement higher interest rates. OECD economists have estimated that QT could increase long-term interest rates by between 50 and 100 basis points (bps) in the US, and between 30 and 80bps in the UK. Nevertheless, the BoE is keen to stress that in the fight against inflation, it is a poor substitute for rate hikes. According to Ramsden, changes in Bank Rate are operationally easy and quick to implement, but also have the advantage of “greater certainty, built up over long experience”.
So far, the impact of QT on gilt yields appears small (see chart), whereas the impact of rising interest rates has been significant. Ramsden calculates that the “vast majority” of the 300 basis point increase in 10-year gilt yields since February last year (when passive QT began) has been driven by increases in expected policy rates, rather than the QT strategy. He concludes that with the QT operation running firmly in the background, the story is “so far, so good”.
Where next?
The BoE will announce a decision on the next phase of QT in October. Ramsden said that it “seems reasonable” for sales to continue at the same pace for the next 12-month period, although added that he thought that a “carefully considered increase” in the pace of QT could also be supported.
Over the very long run, it could allow the BoE to build up some balance sheet ‘firepower’ for when or if interest rates hit zero again. Ramsden said that the tightening has the “important benefit of reducing the risk of a ratchet upwards in the central balance sheet over time”. He added that reducing asset holdings now “increases the headroom and flexibility for the central bank to be able to use its balance sheet”, should it be needed in the future. Rather than erasing the impacts of QE, QT may have paved the way for its return.
