As we look around we see that much of the present economic situation is grim and disappointing, but looking ahead there is hope for recovery and improvement. Much of that is based on vaccines but also some countries have kept the Covid-19 virus under more control anyway. This poses quite a problem for central banks who have deployed monetary policy about as fully as they can. Some of you may remember the previous Bank of England Governor Mark Carney denying that monetary policy was “Maxxed Out”. But now we face a situation where the official Bank Rate is at 0.1% or 0.4% below the level he assured us was the “lower bound” for it.
If we switch to QE (Quantitative Easing) or bond purchases we have also seen intervention on an extraordinary scale with the numbers being updated for the UK by the Bank of England yesterday.
The Committee voted unanimously for the Bank of England to maintain the stock of sterling non-financial investment-grade corporate bond purchases, financed by the
issuance of central bank reserves, at £20 billion. The Committee voted unanimously for the Bank of England to
continue with its existing programme of UK government bond purchases, financed by the issuance of central
bank reserves, maintaining the target for the stock of these government bond purchases at £875 billion and so
the total target stock of asset purchases at £895 billion.
In terms of progress towards that this is where we are.
As of 3 February 2021, the total stock of assets held in the Asset Purchase Facility had reached £759
billion, an increase of £14 billion as part of the £150 billion programme of UK government bond purchases
announced on 5 November 2020.
They are progressing at £4.4 billion a week and also announced that would be the future pace at least until their next meeting.They would argue that this fits with this.
The February Report projections assumed a 4% fall in GDP in 2021 Q1, leaving it around 12% below its
2019 Q4 level.
But things get more difficult as we note it will continue long beyond that into this.
GDP was projected to recover rapidly towards pre-Covid levels over 2021, as the vaccination programme
was assumed to lead to an easing of Covid-related restrictions and people’s health concerns. Consumer spending was expected to rise materially, supported by households running down around 5% of the large pool
of additional aggregate savings accumulated while spending on some activities was restricted……. GDP was projected to reach its 2019 Q4 level in 2022 Q1.
That is rather awkward because they are supposed to be setting monetary policy two years ahead ( as that is the time it takes policy decisions to impact on inflation). So as we are at what might be called emergency squared levels ( as after all a 0.5% Bank Rate was an emergency measure) they have a problem.
The Policy Response
There was a minor one and then a more major shift.
The Committee continued to envisage that the pace of purchases could remain at around its current level initially, with flexibility to slow the pace of purchases later.
That is the more minor one and whilst it looks like a response to an improving economy by reducing purchases it has quite a flaw. Having set a target of £150 billion extra that simply means they will be buying for longer and may end up like the Riksbank of Sweden with a procyclical policy or pumping up a boom.
The more major response was this.
the Committee agreed to ask Bank staff to commence work to reconsider the previous guidance on the appropriate strategy for tightening monetary policy should that be required in the future.
Okay. Now that is good because as you can see below the previous stance was really rather silly.
That previous guidance stated that the stock of purchased assets would be expected to be maintained until Bank
Rate reached a level from which it could be cut materially. And, in June 2018, the Committee had agreed that it
intended not to reduce the stock of purchased assets until Bank Rate reached around 1.5%.
The reason why that was silly is that you are setting out to reduce the price of your bonds by acting like that. So the Bank of England will not only have overpaid on the way in but will have got a lower and depending on circumstances a much lower price on the way out. At a time when central bank ethics are being questioned ( ex central bankers accepting large sums from hedge funds) giving markets an unnecessary free lunch not only looks bad it is a type of soft corruption. There are elements of this that are simply an exchange between the Bank and HM Treasury but it is not only that as private players are involved.
The trail now goes cold and this is because in my opinion they simply want to make it look like they might so this whereas in reality they have no intention at all.
Any reversal here is more problematic and relates to any area where you buy private-sector assets. I pointed out above that even with sovereign bonds not all of the transactions are on the state balance sheet well here many of them are not. We can take that further by looking East.
That is from December and is already out of date because it bought on four more occasions in January. Actually it buys every day for “investment in physical and human capital” but at 1.2 billion Yen they are relatively minor. Although of course it is revealing in itself that 1.2 billion is relatively minor.
The problem here is based on the fact that you have created a false market. What I mean by that is that you put it at a price that it would not otherwise be. This has been an explicit policy aim of the Bank of Japan via the way it bought on down days and last year in increasing amounts. So whilst from a narrow point of view the 437 point rally this morning to 28,779 looks great there is a catch. How do you ever sell your position without sending the market back down? So whilst The Tokyo Whale has a large marked to market profit how does it ever take it? At the extreme we have recently been taught by GameStop the difference between realised and unrealised profits.
Maybe there will be a surge into Japanese equities and it can exit but the catch is that we are near thirty-year highs, so what is high enough?
So there is an issue for reversing QE for both public-sector assets ( government bonds) and private-sector ones ( equities and corporate bonds). The problems are now two fold. The first is something that has been around for a while. Economies have not grown fast enough ( or in some cases at all) in general to help oil such a move. The brief opportunities have been missed ( I wrote a piece in City-AM in September 2013 suggesting it for the UK).
The next is that markets have become dependent on it. For example if we look at the Nikkei 225 equity index we see that it began the year over 27,000 but even so the Bank of Japan bought some 50 billion Yen on four occasions in January. So at what level does it think it can stop? After all we are near to thirty-year highs.
That factor is even more important when we look at bond QE. Government’s have become dependent on the low bond yields that all the QE has created. This is all put very neutrally by the Bank of England.
So how do they stop? Especially as we note that those coming to power ( assuming Mario Draghi does in Italy) are calling for “More! More! More!”
“Much higher public debt levels will become a permanent feature of our economies and will be accompanied by private debt cancellation.” “Such an increase in government debt will not add to its servicing costs.” ( Financial Times op-ed)