MNI INTERVIEW: Gilt Spikes Make Case To Slow QT - NIESR Head

Greater UK fiscal discipline would allow the Bank of England to offer to slow or stop its active gilt sales, relieving pressure on government financing costs, the director of the influential National Institute for Economic Research David Aikman told MNI.

Yields on 10-year gilts have risen to around 5% in recent weeks and the 30-year to as high as 5.8%. The BOE might be prepared to help, said Aikman, a former senior BOE official.

"There may be a world where there's a bargain that could be struck ... if we could have some fiscal consolidation, the Bank would do more [on reducing] QT," he said.

"I don't think the Bank thinks it's needed for monetary policy right now. It's doing it because it wants a smaller balance sheet," Aikman said, and this raises "the question about whether there could be a coordinated outcome that would be better where there'll be less QT happening, and the quid pro quo would be the government works harder to bring down the debt level, or at least the deficit."

From the BOE's perspective, gilt sales are set in stone until September, having announced the schedule last autumn. By September, the balance of gilts held in the APF will be just below GBP500 billion, around the upper end of the estimate of PMRR levels, giving the Bank flexibility.

While the Bank for International Settlements has called for minimum haircuts and a greater use of central clearing to reduce volatility risks in sovereign debt markets increasingly dominated by hedge funds, Aikman doubted this would lead to action.

"Where the U.S. is right now, it seems completely implausible to me that there'll be an international, co-ordinated minimum haircut on government bonds, and I think that there's absolutely no possibility that the UK would move unilaterally. So that seems like a non-starter to me," Aikman said. (See MNI INTERVIEW: Must Tackle Hedge Fund Debt Risk - BIS's Gelos).

SLIGHT FINANCIAL CONDITIONS TIGHTENING

The BOE held Bank Rate at 3.75% at its April meeting, with its Monetary Policy Summary pointing to a tightening in financial conditions since the beginning of the Iran war, which it said would help constrain any rise in inflation. However, Aikman questioned the degree to which financial conditions have really tightened and whether this justifies delaying hiking.

Comparing the gilt curve to the day before the onset of the Gulf conflict, "the short end is up about 100 basis points. That's more than accounted for by inflation compensation," he said, noting the ten-year rate is above the five-year. 

"I think an immediate question it raises is, is this a reflection of expectations of monetary policy, or something beyond that? ... My prior would be, you can't just account for these moves through expectations of monetary policy."

While the gilt curve has risen, Aikman questioned "How much have financial conditions broadly actually tightened? Because we don't just think of the risk free curve, but we think of equity markets, credit, foreign exchange, mortgage markets, all of that stuff. And I think there, it's less clear to me," as various financial measures reversed their March tightening in April.

"If you took that view that some components of financial conditions had tightened for exogenous reasons, then there may be a case for offsetting that with looser monetary policy. That appears to be part of the thinking in the MPR (Monetary Policy Report)."

Clearly, such thinking would not work if the tightening was due solely to expectations of BOE policy.

"I think it is a basic point that goes back to Mervyn King's famous speech on his Maradona theory... this idea that ... 'I'm not acting, because the market's acting for me, and I've done the body swerve, and it's tricked all the defenders. That only works logically if you follow through ...Otherwise, the curve would just come back down again If people thought the Bank wasn't actually going to tighten."