The focus of next week’s Bank of England-BoE decision will not just be about benchmark interest rates. At a time when central bank meetings are most often scrutinised for clues regarding the outlook for domestic interest rates, this particular BoE meeting will have an important distraction. The next monetary policy decision is due next Thursday. As well as setting benchmark rates, the BoE will set out further plans regarding the unwinding of its balance sheet. With rates likely to remain on hold until the November meeting, much of the focus will be on the BoE’s plans to unwind its asset purchase programme.
With a balance sheet approaching a trillion dollars in value, the BoE holds a colossal value of assets on its books. The product of many asset purchase programmes to stimulate or protect the UK economy now presents an opportunity to control monetary policy. Currently, active sales of bonds are limited, and balance sheet reduction is mainly achieved by not reinvesting maturing bonds. As Labour’s fiscal ambitions become increasingly controversial, balance sheet reduction will also be politicised as loss making bonds sales affect the government’s budget. Any plans to scale up active asset sales will prove to be highly market sensitive.
At present the BoE is coming under scrutiny for its asset sale programme. There is a good opportunity to reduce its balance sheet to a more typical size whilst the need for monetary loosening is limited. However, currently the BoE’s asset purchase programme is a major holder of short dates bonds and arguably limiting liquidity in short-dated gilts. There are no current plans to include gilts with a maturity less than three years in the balance sheet reduction programmes. However, next week’s decision could allow the BoE to redefine its ambitions to reduce its balance sheet. Stresses and liquidity in the short-term interest rate market shouldn’t be ignored and could catalyse further volatility for UK assets including the pound.
Discussion and Analysis by Charles Porter
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