MNI INTERVIEW: Ex-BOE Markets Head Doubts Mass Repo Tactic

The Bank of England's attempt to sell off its bond holdings and to meet banks' demand for reserves through heavy use of repo operations may be unachievable, former BOE Executive Director Markets and Monetary Policy Committee member Paul Fisher told MNI.

The BOE is transitioning from an excess reserves system, made possible by its asset purchases during quantitative easing, to a demand-driven framework, but Fisher noted that the desired levels of reserves may be as high as GBP600 billion, compared to the current GBP661.7 billion, and to the BOE's survey based preferred minimum range of reserves estimate of GBP385-GBP540 billion.

Maintaining such a high level of reserves through repo could be operationally difficult, he said in an interview.

"They've set out their vision of doing it mostly through repo, but within that, they envision it mostly being ... more long-term repo ... and more level-C collateral. And I don't know whether they're going to be able to achieve that," said Fisher, now an honorary professor at Warwick Business School.

 "I'm not sure that they will be able to get to a system where it is mostly repo, or that they will get the level C assets as collateral that they are encouraging ... That's why they need to be flexible.”

If participants in repo operations largely offer short-dated gilts as collateral there would be a circular effect as the BOE sells off its short-dated gilts, he said.

If "it's all Level A collateral that's not a problem, but just means the banks have to hold a lot more gilts than they used to ...[It's] not too bad for the system either, because you're selling gilts with one hand, and then the banks are going to have to hold more short-dated gilts to use as collateral in the borrowing operation. Apart from the likely maturity difference, it's a complete circle," Fisher said.

The data already show short-dated gilt prices increasing relative to long-dated gilts, as demand from banks seeking the former for collateral appears to be one driver of the steepening yield curve.

MPC SPLIT

The majority of the MPC voted in September to slow the pace of balance sheet reduction to GBP70 billion over 12 months. However, chief economist Huw Pill supported a steady GBP100 billion pace, and former MPC member Michael Saunders has advocated stopping active gilt sales altogether and holding the gilts on the Bank's balance sheet. Fisher sympathised with both concerns. (See MNI INTERVIEW:  BOE To Cut Long Gilt Sales - Ex-MPC's Saunders)

"The reason for saying 'set the pace and keep doing it' is because you want to give the market certainty … [but] I also think they're not far away from the desired level of reserves and then they could stop," Fisher said, adding that neither view is dominant.

"It's more under their control if they're doing repo, and it's less risky in that the Bank doesn't get mark-to-market fluctuations in the value of their assets. On the other hand, if they do keep a portfolio of gilts, it's less operationally risky, because you're not having to do the same size operations and you would expect a higher rate of return over time if the yield curve is upward-sloping," he said.

AXING RESERVE REMUNERATION

A complicating political factor for the Bank is that the idea of tiering, or even axing, reserve remuneration is moving into the political spotlight, with two opposition parties, Reform and the Greens, supporting its elimination. That would force the BOE to overhaul its demand-led system and look at alternatives such as minimum reserve requirements.

"It's got nothing to do with monetary policy or the objectives of the Bank of England and it's complicated. You'll take more resources to run it. So why would the Bank ever choose to do that? It's a purely fiscal decision," Fisher said. 

"They could be instructed to do it. If so then it should be made clear it's the government's policy, not a central bank policy. It is a further tax on the banking system," he added.

Fisher did note that “the moment tiered remuneration became a political matter, [the Bank] can’t really say much.”