The Bank of England, QE Revisited, Day 2 ..... oh dear, this is not how it was supposed to go at all!

Wednesday 10th August 2016

The Bank of England, QE Revisited, Day 2  ..... oh dear, this is not how it was supposed to go at all!

ref:- "BOE Can't Part Investors From Long Bonds as QE Hits Snag", Bloomberg Online

This week has seen the start of the key element of the Bank of England's forceful response to the economic concerns posed by the Brexit vote, the resumption of the central bank's bond-purchasing programme designed to suppress yields and encourage lending and investment (QE). Given that Governor Mark Carney has a frequently-expressed distrust of negative rates, and that the BoE has already brought down the headline rate to 0.25%, one might argue that the success of this new wave of QE is pretty crucial to the Bank's grand plan. Its inability therefore to purchase the full amount of bonds it was after, on just the second day of the programme, has to be seen as embarrassing, or worrying, or both.

The BoE's intention is to buy £60 billion of UK government bonds , spread over a range of maturities. Things had started well enough on Monday, when the first foray into the short end of the market (maturities of 3 to 7 years) in search of £1.17 billion of gilts was easily covered with offers 3.63 times that amount. Yesterday was a different story ..... in its attempt to purchase the same amount of long-dated gilts (£1.17 billion with maturities of 15 years or more), the Bank could only find offers of £1.118 billion despite bidding some way above market prices. Today, buying will start in the 7 to 15 year range of maturities.

A shortfall of £52 million doesn't sound a lot in the greater scheme of things, but difficulty in finding stock so early in the programme is significant. Satisfying the BoE's demand in the longer end was always going to be the most difficult. In a world largely devoid of safe sources of yield, those investors locked into higher-yielding long bonds are not tempted to sell. If you've previously bought a bond at a higher yield (and therefore a lower price) , selling now would show a capital return but where would you go to find decent income for the future? This is a particular problem for pension funds, who are such major players in the gilt market and need a decent and ongoing level of yield to meet their liabilities.

If was just a question of £52 million pounds, that could easily made up by switching the maturity of the bonds to be purchased or by making it up at a later date. The Treasury could respond by switching more of its future issuance to the long end. This seems likely when you consider the scarcity of long bonds to meet the new demand. That scarcity means that the long-dated bonds are outperforming (new record low yields in the 30 year of 1.30%) and that the yield-curve is flattening. It's not a scenario that inspires confidence in any robust growth and inflationary pressure, and it's not a problem that is likely to go away. Something else the BoE may struggle with is their plan to buy £10 billion in corporate bonds  --  in comparative terms, the UK's corporate bond market is not large and the experts suggest the numbers may not be realistic.

The Bank of England has been congratulated on its bold decisions, but the execution of its plans will plainly not be straightforward. Of course, globally speaking there's nothing new in that ..... the Bank of Japan's QE programme has seen it become the not-so-proud owner of an unhealthy percentage of Japanese government bonds and in the Eurozone the ECB, obliged to exercise its purchases of individual member nations' debt proportionately to their economic weight, will face real problems in finding suitable amounts of German Bunds, for example.

The whole issue also brings us back to another of the most fundamental debates of the modern age ...... just how much can we expect monetary policy to do on its own, and shouldn't we now be looking for more stimulus on the fiscal side? The post-Brexit Conservative government in the UK has been distancing itself from its earlier, austerity-driven incarnations and looks open to the idea of having to spend to achieve growth..... which may be just as well. With interest rates very nearly as low as they can go (if Mr Carney is to be believed) and implementation problems afflicting QE, monetary stimulus may be close to being tapped out.