LONDON (MNI), Nov 23 – Gilt market constraints are imposing a limit
on the speed at which the Bank of England Monetary Policy Committee can
carry out quantitative easing, making any acceleration before February
highly unlikely and capping the amount of QE the MPC is likely to
approve at that time.
At the margins, analysts say the speed limit makes it more likely
the MPC sanctions Stg50 billion of QE in February rather than Stg75
billion and it certainly weighs very heavily against approving increased
asset purchases before the current buying round ends.
The “speed limit” on QE raises some questions over the MPC’s
communication strategy and it is striking the way in which MPC members,
who have varying degrees of market expertise, appear to have
collectively adopted the idea.
Bank of England Governor Mervyn King made no mention of gilt market
constraints on policy when, at his post November Inflation Report press
conference, he set out the reasons behind the MPC’s decision not to step
up QE.
The Inflation Report showed CPI heading well below the 2.0% target,
to just under 1.3%, two years’ ahead, raising the obvious question why
the committee did not approve more stimulus in November.
The BOE Governor argued that, having sanctioned Stg75 billion of QE
over four months at its October meeting, it was no time for fine-tuning
policy and he also said they wanted to see if inflation did come down as
the report forecast.
King appeared to be following the MPC usual strategy of implying
has freedom of action, with no policy constraints imposed by markets.
In an interview with the Financial Times the same week, however,
MPC Martin Weale cited the practical problems they would have in the
gilt markets if they increased the pace of QE.
“If we were to make very large purchases in any month then there’s
a risk that this could be a source of disruption of the orderly
management of the gilts market,” he said.
The minutes of the November MPC meeting, out Wednesday, also showed
the potential problems accelerating QE would cause in the gilt markets
were discussed.
“Market capacity made it difficult to increase the monthly rate of
purchases substantially above what was already under way,” the minutes
said, recording no dissenters from this view.
The current rate of gilt purchases is running at Stg5.1 billion a
week. The cover ratios at the longest maturity reverse auctions, the
over 25 year ones, have been pretty low, averaging just 1.65 with a
median of 1.72 over the first seven auctions.
The initial over 25 year gilt auctions, starting in August 2009,
were heavily covered with the first getting 3.74 cover and the second
2.52. Supply, however, then tailed off and median cover ran pretty much
in line with where it is has been under the second wave of QE, at 1.84
over the first seven auction.
When QE was first launched, back in March 2009, the BOE steered
clear of the longest and shorter dated gilts, restricting purchases to
the 5 to 25 year range. In August that year, with the BOE starting to
buy larger proportions of some gilts, it extended the range to anything
over 3 years.
The BOE’s thinking was, with banks under pressure to hold long
dated gilts for capital adequacy reasons and pension funds for liability
matching purposes, there could be a shortage of supply.
The second wave of QE is highlighting the supply problem. There are
anecdotal reports of fund managers being extremely reluctant to dispose
of gilts, with so many other sovereigns under pressure, and with year
end approaching. Even the 10 to 25 year auction on Wednesday only got
1.64 cover.
The current round of Stg75 billion QE will be completed by
February, and a near consensus view among analysts, at least post the
minutes, is it will not be increased before then.
Philip Shaw, economist at Investec, points out it would be absurd
for the MPC, having voted against even a Stg25 billion QE extension in
November, to then vote for more QE a month later to be completed over
the same timeframe, as this would amount to an even faster pace and
intensify the market constraint problem.
What is a moot point is whether the speed limit weighs
significantly in favour of the MPC sanctioning Stg50 billion or Stg75
billion in February. It also raises the questions whether the central
bank can find ways to raise it.
As the current Stg75 billion of asset purchases are being carried
out over four months, taking it up to the February Inflation Report
forecast round, if the MPC sanctioned another Stg75 billion in February
to take it up to the next report in May it would mean accelerating QE.
The increase would only be relatively small, at least by QE
standards, with the current round of purchases having to factor in some
catch up because of the Christmas break. Another Stg75 billion would
amount to Stg6.25 billion per week over the 12 weeks compared to the
current Stg5.1 billion.
An intriguing point is whether the BOE could extend the asset
purchase basket. So far under QE it has not bought any index linked
gilts.
Two reasons have been advanced for this – firstly that it would
distort inflation expectations and secondly that many institutions buy
linkers to hold them, and the BOE would struggle to get them to sell.
Rush says the first reason is not persuasive. In buying
conventional gilts and not index linked one the BOE is already
distorting break-even inflation rates – which are based on the
difference between fixed rate and inflation linked yields.
The question of whether there will be adequate supply of inflation
linked gilts at a BOE reverse auction simply mirrors the question asked
about the longest dated gilts.
One thing has been made crystal clear by the minutes and Weale’s
comments. MPC members are publicly acknowledging the freedom they have
to set policy does face market constraints.
— London Bureau +20 7862 7491; drobinson@marketnews.com
[TOPICS: M$$BE$]
