Investors are starting to wonder how long the Bank of England can count on buying bonds as the primary vehicle for stimulating the UK economy.
Markets are ready for the BoE to announce a new round of quantitative easing at its political meeting on Thursday. Many economists are anticipating £ 100 billion of additional purchases on top of the £ 300 billion announced earlier this year to help cope with the economic impact of a Covid-19 resurgence.
Looking ahead to the next year, however, some analysts and investors argue that the effectiveness of additional government debt purchases is waning or that the BoE will eventually run out of bonds to buy. This, in turn, makes it more likely that BoE Governor Andrew Bailey and his colleagues could take the controversial move of lowering interest rates below zero as they look for new ways to stimulate a flagging economy.
“The Bank of England has run out of space with QE,” said Daniela Russell, head of UK interest rate strategy at HSBC. “They’ll probably be looking for a better way to get more bang for your buck.”
After recent asset purchases, the BoE now owns 44 percent of outstanding government bonds, roughly double the Federal Reserve’s stake in US Treasuries.
The central bank’s rulebook allows this number to be raised to a maximum of 70 percent, but in practice policymakers may feel uncomfortable long before that level is reached, argues Ms. Russell.
One reason the Bank of Japan moved to a yield curve control policy aimed at fixing yields at predetermined levels rather than making regular purchases was that its 50 percent stake in the Japanese government bond market went to retail investors harmed. Ability to act, she said.
Mr Bailey has pointed out that QE is more effective if the central bank can get “big and fast”, as it did with an explosion of buying at the height of the Covid crisis earlier this year. His colleague Gertjan Vlieghe, who set interest rates, echoed those concerns last month when he said “QE is likely less effective now than it was in March”. This could be more difficult to achieve in the future when it hits property lines.
Others argue that it is too early to talk about a linchpin away from quantitative easing. According to Peter Goves, European interest rate strategist at MFS Investment Management, even if the BoE thinks about new guidelines, they should stand alongside a continuation of regular gold purchases for the foreseeable future. Although the central bank was quickly sucking up government bonds, the government’s debt management bureau recently issued new ones even faster.
“Of course, a lot depends on what the DMO does, but I don’t think there are any short-term limitations,” said Goves. If necessary, the BoE buying could lean towards longer-term gilts, a segment of the market where their ownership is slightly lower, he added.
Still, some investors are betting that HSBC’s analysis will prove correct and that the BoE will have to look for new ways to stimulate the economy.
One possibility is for the BoE to follow the Japanese example and introduce a return target that will allow it to keep government borrowing costs – along with corporate and household borrowing – down without spending so much on bond purchases. Most analysts believe that such a move is unlikely, however.
For the time being, this also applies to a further interest rate cut compared to the current record low of 0.1 percent, with the BoE still investigating the possible effects of negative interest rates on the banking sector. However, once that consultation is completed by the end of the year, the rate cuts will be back on the table, said Sandra Holdsworth, head of UK rates at Aegon Asset Management.
“I think they want more than one tool available – right now it’s QE or QE,” she said, adding that she is positioned for lower gold yields on the assumption that at some point the BoE will be forced to go under to cut zero.
The markets are currently anticipating a decline in interest rates to around minus 0.05 percent by the middle of next year. But once the BoE catches the nettle of negative interest rates, it will likely go further, Ms. Holdsworth thinks.
She said, “You will get there sometime. And if you go to the effort of doing it, there isn’t much point in doing it in tiny steps. “