Investors are beginning to question how long the Bank of England can rely on bond buying as its main tool for stimulating the UK economy.
Markets are braced for the BoE to announce a fresh round of quantitative easing at its policy meeting on Thursday, with many economists pencilling in an extra £100bn of purchases on top of the £300bn announced so far this year, to tackle the economic impact of a resurgence of Covid-19.
But looking ahead to next year, some analysts and investors argue that the effectiveness of additional government debt purchases is dwindling, or even that the BoE will eventually run out of bonds to buy. That in turn makes it more likely that BoE governor Andrew Bailey and his colleagues could take the controversial step of cutting interest rates below zero as they seek new ways to stimulate a flagging economy.
“The Bank of England is running out of room with QE,” said Daniela Russell, head of UK rates strategy at HSBC. “They are likely to start looking for a better way to get more bang for their buck.”
Following its latest rounds of asset purchases, the BoE now owns 44 per cent of outstanding government bonds, roughly double the proportion of the Federal Reserve’s ownership of US Treasuries.
The central bank’s own rule book allows this figure to rise to a maximum of 70 per cent but, in practice, policymakers could start to become uncomfortable well before hitting that level, Ms Russell argues.
One reason that the Bank of Japan switched to a policy of yield curve control, aiming to pin yields at a pre-determined level instead of conducting regular purchases, was because its 50 per cent stake in the Japanese government bond market was hurting private investors’ ability to trade, she said.
Mr Bailey has indicated that QE is more effective when the central bank can “go big and fast” as it did with an explosion of purchases at the height of the Covid crisis earlier this year. His rate-setting colleague Gertjan Vlieghe echoed those concerns last month when he said “QE is probably less potent now than in March”. That could become harder to achieve in the future if it is bumping up against ownership limits.
Others argue that it is too soon to start talking about a pivot away from quantitative easing. Even if the BoE contemplates new policies, they are likely to sit alongside a continuation of regular gilt purchases for the foreseeable future, according to Peter Goves, European interest rate strategist at MFS Investment Management. Although the central bank has been hoovering up gilts at a rapid rate, the government’s debt management office has been recently issuing new ones even faster.
“Of course a lot depends on what the DMO does, but I don’t think there’s a constraint in the near term,” Mr Goves said. If necessary, the BoE could tilt purchases towards longer-dated gilts, a segment of the market where its ownership is slightly lower, he added.
Even so, some investors are betting that HSBC’s analysis will prove correct, and the BoE will have to search for new ways to stimulate the economy.
One possibility is that the BoE could follow the Japanese example and introduce a yield target, in effect allowing it to hold down government borrowing costs — along with those of companies and households — without spending as much on bond purchases. But most analysts think such a step is unlikely.
For now, so is a further reduction in interest rates from the current record low of 0.1 per cent, with the BoE still examining the potential effect of negative interest rates on the banking sector. But once that consultation concludes at the end of the year, rate cuts will be back on the table, according to Sandra Holdsworth, UK head of rates at Aegon Asset Management.
“I think they would like to have more than one tool available to them — at the moment it’s QE or QE,” she said, adding that she is positioned for lower gilt yields on the assumption that the BoE will eventually be forced to cut below zero.
Markets are currently pricing in a decline in interest rates to roughly minus 0.05 per cent by the middle of next year. But once the BoE grasps the nettle of negative rates, it is likely to go further, Ms Holdsworth thinks.
She said: “They will get there eventually. And if you are going to go to the trouble of doing it, there’s not much point doing it in tiny increments.”
Source: Economy - ft.com
