Next Central Bank Puts QE Unwind on the Calendar

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Wolf Richter,

The end of an era spreads.

Markets were surprised today when the Bank of England took a “hawkish” turn and announced that three out of nine members of its Monetary Policy Committee – including influential Chief Economist Andrew Haldane, who’d been considered dovish – voted to raise the Bank Rate to 0.75%, thus dissenting from the majority who kept it at 0.5%. This dissension, particularly by Haldane, communicated to the markets that a rate hike at the next meeting in August is likely. The beaten-down UK pound jumped.

But less prominent was the announcement about the QE unwind. Like other central banks, the BoE heavily engaged in QE and maintains a balance sheet of £435 billion ($577 billion) of British government bonds and £10 billion ($13 billion) in UK corporate bonds that it had acquired during the Brexit kerfuffle.

Before it starts shedding assets on its balance sheet, however, the BoE wants to raise the Bank Rate enough to where it can cut it “materially” if needed, “reflecting the Committee’s preference to use Bank Rate as the primary instrument for monetary policy,” as it said.

In this, it parallels the Fed. The Fed started its QE unwind in October 2017, after it had already raised its target range for the federal funds rate four times.

The BoE’s previous guidance was that the QE unwind would start when the Bank Rate is “around 2%.” Back in the day when this guidance was given, NIRP had broken out all over Europe, and pundits assumed that the BoE would never be able to raise its rate to anywhere near 2%, and so the QE unwind could never happen.

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Today the BoE moved down its guidance about the beginning of the QE unwind to a time when the Bank Rate is “around 1.5%.”

The Fed’s target range is already between 1.75% and 2.0%. The Fed leads, other central banks follow. And by August 2, the BoE’s Bank Rate may be at 0.75%. From that point forward, the QE unwind may only be three rate hikes away.

“Any reduction in the stock of purchased assets will be conducted at a gradual and predictable pace,” it added, very Fed-like.

The thing is, there’s an inflation problem in the UK. Inflation has been above the BoE target of 2% since February 2017, hitting 3% and beyond for five months in a row late last year and early this year. This has squeezed real household incomes (adjusted for inflation), crushed the savings rate, and hampered consumer spending.

The BoE tolerated this after the Brexit referendum. But recently it has gotten nervous about it. And now it’s time to do something. The BoE’s statement on consumer price inflation:

CPI inflation was 2.4% in May, unchanged from April. Inflation is expected to pick up by slightly more than projected in May in the near term, reflecting higher dollar oil prices and a weaker sterling exchange rate.

And its statement on wage inflation, which is what central banks are really allergic to:

Most indicators of pay growth have picked up over the past year and the labour market remains tight, suggesting that domestic cost pressures will continue to firm gradually, as expected.

This is how it fits into the “ongoing tightening”:

The Committee’s best collective judgement remains that, were the economy to develop broadly in line with the May Inflation Report projections, an ongoing tightening of monetary policy over the forecast period would be appropriate to return inflation sustainably to its target [down to 2%] at a conventional horizon.

And then, when it explains what this means for the future, there appears the Fed’s favorite word again, “gradual”:

All members agree that any future increases in Bank Rate are likely to be at a gradual pace and to a limited extent.

The BoE is the second major central bank that has put the QE unwind on its schedule, after the Fed has already plowed ahead with it. By contrast, the ECB is still engaging in QE, but has been tapering it, and will end it this December, with rate hikes likely to begin next year. But a QE unwind won’t be on its schedule until after’s Draghi’s shelf life expires in October 2019.

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