-Uncertainty Lingers Over Accounting Treatment Of QE Cash Transfer Move
-QE Cash Transfer To Drive Up Inflation Report’s CPI Forecast

LONDON (MNI) – Friday’s announcement that the Bank of England will
transfer coupon payments on its stock of gilt purchases to the Treasury
will add to inflation and paves the way for the government to declare
it is back on track to hit its debt reduction target, analysts say.

Uncertainty lingers over the precise implications of the coupon
transfers, as their impact depends on when QE is unwound and exactly how
it is accounted for in official statistics. The crystal clear impact is
they will make planned gilt issuance lower, cutting government interest
payments, and will add to projected inflation.

The widespread view among analysts, is that the transfers also make
it more likely that when Chancellor of the Exchequer George Osborne
stands up to unveil his Autumn Statement on December 5 he will be able
to say the public finances are on track to hit the debt reduction
target.

-Boost To Debt Reduction

Prior to Friday’s announcement there were widespread media reports
that Osborne would have to announce on Dec 5 that the public finances
were set to miss the debt reduction target. Now, he may be able to dodge
that bullet.

The BOE announced on November 9 that it is handing the excess cash,
essentially gilt coupon income, that has built up in its QE vehicle, the
Asset Purchase Facility, to the Treasury. That is a windfall to the
Treasury of some stg11 billion in this fiscal year and another stg23.8
billion in 2013/14.

The independent Office for Budget Responsibility is charged with
asessing whether the public finances are on track to meet the deficit
and debt rules, with the latter stipulating net debt should be on a
declining path in fiscal year 2015-16.

By combining the windfall from the coupon transfers with some small
beer fiscal measures “they will able to fudge it so that the OBR says
they will be able to meet the (debt) rule,” Philip Rush, economist at
Nomura, says.

Rush points out that by reducing debt levels, the Treasury will
have to pay less interest, with transfers feeding straight through
to lower gilt issuance, and this means that for any given level of GDP
the debt/GDP ratio improves.

The timing of QE unwind complicates the picture, at least in
theory. Prior to the news about the transfer of excess cash balances
from the APF to the Treasury. one arm of the public sector, the
Exchequer, was making coupon payments to another, the APF. When the MPC
decides to unwind QE by selling gilts, the transfer of funds will
reverse with payments again going from the government to the APF.

Bank of England officials have repeatedly said, however, that in
tightening monetary policy they will use Bank Rate as the active
instrument. On current SONIA pricing the first hike in Bank Rate is not
expected until at least five years out, or the 2017/18 fiscal year,
and large scale gilt sales by the APF may only be made after this.

With the debt reduction target centred on the 2015/16 year, the
impact of QE unwind looks like a red herring.

More significantly, what the coupon transfer move does for the
Treasury in it its efforts to meet the debt rule is “it gives them the
scope to do it,” Simon Hayes, Chief UK Economist at Barclays, says.

Hayes makes that point that by pushing down on debt levels,
Treasury officials will have greater scope to engineer a declining
debt/GDP profile in 2015-16.

While the media ran with the ‘government to miss debt target’
story, economists say that privately, and even publicly, the Treasury
message has been there will be no slippage.

“I’m amazed the story ran as long as it did,” Hayes says.

-Impacts Inflation Report

The way to think of the coupon move as monetary stimulus is that it
will have exactly the same effect as a corresponding amount of
conventional QE, says Robert Wood, Berenberg Bank’s Chief UK Economist.

The BOE own estimates, in a paper co-authored by Wood in his time
at the BOE, suggest that at peak the first stg200 billion of QE added
0.75 to 1.5 percentage point to CPI. Using those ready reckoners, stg35
billion would add just over 0.25pp to CPI at maximum.

The impact of the coupon transfers on the BOE’s two- and three-
year ahead inflation forecasts, however, is likely to be the least of
BOE Governor Mervyn King’s worries at the press conference following
the publication of the report Wednesday.

He will, inevitably, be grilled over the announcement’s apparent
infringement of central bank independence – what RBC Chief European
Economist Jens Larsen describes as its conflation of monetary, fiscal
and debt management policies.

The November Inflation Report itself is widely expected to show an
inflation profile that is similar to, but a little above, that in the
August report.

That showed CPI falling from an average 2.19% in Q4 this year to
below its 2% target in Q4 2013 and standing at 1.7% in Q4 2014.

Wood expects this report to show a 50/50 chance of inflation
being above its 2.0% target two years ahead, with a modal forecast of,
say, 1.8% two years out rising close to the 2.0% target three years out.

That, Wood says, would leave the door open to more QE – but would
also sit comfortably with the expectation the MPC will sit tight until
it can review things in its next quarterly forecast round for the
February Inflation Report.

-London newsroom: 4420 7862 7491; email: drobinson@marketnews.com

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