–BOE Gilt Buys Could Tilt Towards Longer End As QE Gets Going
–Some Analysts Skeptical BOE Will Announce Targeting Longer End

LONDON (MNI) – If the Bank of England’s Monetary Policy Committee
does relaunch quantitative easing (QE) analysts expect QE2 to look
pretty much like QE1, with the one hot topic of debate being whether the
central bank will focus its gilt buying towards the longer end of the
yield curve.

The widespread view is that the MPC will not, at least in its
formal policy statement, announce a shift in asset buying towards to the
longer end of the gilt curve. Opinions divide over whether any move
along the curve only materializes through time or whether the central
bank explicitly raises the maturity threshold for gilts it purchases.

In comments to Market News, analysts and strategist reflected on
three possible twists to QE1: focusing on longer dated gilts; credit
easing and cutting reserve remuneration.

Only the first is seen as a plausible policy at this stage. Credit
easing, as Chancellor of the Exchequer George Osborne made crystal clear
in a speech this week, is going to be a matter for the Treasury – with
the BOE acting as its agent.

Additionally, the idea of cutting central bank reserve
remuneration, or any portion of it, is fraught with technical
difficulties, and would hold little appeal for the BOE.

–Tilt to the Longer End of the Gilt Curve ?

When the BOE first launched QE, back in March 2009, it restricted
its gilt purchases to those in the five to 25 year sector. At its August
2009, having gone through stg125 billion of asset purchases, it
announced it was extending the range of maturities it was buying to all
longer than 3 years.

Anthony O’Brien, strategist at Morgan Stanley, said he expected the
BOE in QE2 to push up the maturity threshold. He predicts it will say it
is purchasing gilts with maturities of longer than seven years all the
way out to 2060 maturities.

“They will try and make as big a splash as possible,” he said.

An alternative view is that in practice the BOE may end up tilting
towards longer dated gilts, this would only emerge over time.

On this view, the BOE could leave the announced purchase range
exactly the same as at the end of QE, at over 3 years, and buy, perhaps
only moderately, larger proportions of longer dated gilts through its
regular reverse auctions.

Jens Larsen, chief European economist at Royal Bank of Canada and a
former BOE official, says “I think there may be a slight tilt” towards
the longer end but adds “I very much doubt they will announce it.”

Larsen says that in the first wave of QE the BOE avoided the
longest dated gilts because of the problem that banks, for capital
adequacy reasons, and pension funds, needed to hold them.

The BOE in targeting the 5 to 25 maturity range ended up buying big
chunks of some issues.

The problem was partly one of liquidity and partly “they ended up
owning a very large proportion of some gilts and they didn’t like it,”
Larsen says.

The BOE instituted, informally, a cut off point around 70% for its
ownership of the “free float” for any single gilt (the free float is the
nominal amount outstanding excluding government holdings).

Some analysts are deeply skeptical than even in practice the BOE
will want to move further along the curve than under QE1.

On this view, the wide maturity target range gives the BOE
operational freedom and the peculiarities of the UK market raise
questions as to why the BOE would want to aim for the longer end.

Peter Dixon, economist at Commerzbank, highlights the difference
between the situation facing the BOE and that facing the US Federal
Reserve, with the latter recently unveiling plans, through “Operation
Twist”, to lengthen the maturity of its portfolio.

Dixon says the median maturity of gilts purchased in QE1 by the BOE
was 9 years, and it already has many long maturity gilts. Also, UK
mortgages are typically priced off the short end of the swaps curve so
driving down longer gilt yields will not, in any straight forward way,
reduce a big chunk of household borrowing costs.

–London newsroom 0044 20 7862 7491; email: drobinson@marketnews.com

[TOPICS: M$B$$$,M$$BE$]