MNI INTERVIEW: BOE To Cut Long Gilt Sales - Ex-MPC's Saunders

The Bank of England is now required to factor interest-rate risk into balance sheet decisions and its September announcement on year-ahead asset sales will point to only modest sales of long-dated gilts, two-term Monetary Policy Committee member Michael Saunders told MNI, adding that it would be best to indicate that a large portion of them would never be sold.

With the government keen for the BOE to help to improve the resilience of the UK’s public balance sheet, and the long end of the curve under pressure from the demise of defined benefit pension schemes, the BOE could simply announce that it would never sell a significant portion of its longer-dated gilts, Saunders, who sat on the MPC from 2016-2022 and is now at Oxford Economics, said in an interview. (See MNI INTERVIEW: Lower Long Gilt Demand Risks Volatility - Miles)

While another approach, suggested by some in the market, might be to include some more mid-maturity bonds in the long-end bucket for the BOE’s sales operations, he thought this would achieve little.

"If you're shortening maturity buckets, but still say you're going to sell the same proportion of longs, people won't know as to whether your over-15 bucket is going to mean you're going to sell lots of 15-year or lots of 40-year. And so they'll presumably fear the worst and prepare for the worst, in which case you don't achieve your calming effect on the long end," he said.

Instead, the BOE could announce it had no plans to sell a large proportion of the GBP163 billion in long-dated gilts in its Bank Asset Purchase Facility, and transfer them to its balance sheet as a counterpart to the currency stock, Saunders said.

“If at some point down the road, five years’, 10 years' time, if they want to make a different decision, then fine. It just removes the issue for the next few years ... [meanwhile] they've got plenty of shorts and mediums to sell."

Saunders was dismissive of any suggestion that this would be monetary financing.

"Nonsense. Back in pre-QE days [the Bank] used to hold bonds to match the currency stock. This is just a version to what they used to do," he said.

BOE AWARE OF INTEREST RATE RISK

The BOE did not take account of interest rate risk when it purchased bonds via quantitative easing, as the government had promised to cover any eventual losses, Saunders said.

"I think Bank of England has been on a learning curve for this. In the early days of QE, in essence, they were told, don't worry about interest rate risk. You've got an indemnity [from the Treasury]," he said.

"I think what you saw through the successive rounds of QE, and I say this more in hindsight than something I was thinking of at the time, is there was a  lack of focus by the Bank and Treasury combined on the effects of QE, the extent to which it shortened the maturity of the public sector balance sheet ... there's never any strategic thought to 'Okay, is this the right? What are we doing to the resilience of the public sector balance sheet'?"

Governor Andrew Bailey "to his credit, has been highlighting this in the previous couple of years … the driving force for the shift to a repo-based system ... was to remove interest rate risk from the Bank of England's balance sheet. The Treasury's clearer instructions on that mean that it's no longer just the Bank of England having a preference to reduce interest rate risk, the Treasury are telling them to reduce the interest rate risk," Saunders said.

BANK NOT MPC DECISION

The decision over long-dated gilt sales is one for the Bank executive and not the Monetary Policy Committee,  though the BOE’s Governor and deputy governors sit on both bodies, Saunders noted.

"The only decision which is MPC is the quantity of QT. Everything else is a BOE decision," he said, adding "obviously, there's quite an overlap between MPC and BOE executive members,” he said.

If the decision is taken to keep "gilts on balance sheet as a counterpart to stock of notes and coins, then basically the BOE executive would make that decision, and they would then brief the MPC," Saunders added.