MNI INTERVIEW: QT Raises Yields, BOE To Slow Sales- RF's Smith

The Bank of England may have underestimated the effects of quantitative tightening on gilt yields and this will add to arguments for reducing the programme’s pace next week when the Monetary Policy Committee fixes a fresh target for cutting its gilt stocks over the next 12-months, Resolution Foundation Research Director James Smith told MNI.

While the Bank has been encouraging people to think of quantitative tightening as being "like watching paint dry", it is adding to pressure on gilts, said Smith, noting that that UK government debt yields are at the top of the pack among advanced economies despite debt and deficit levels being only mid-table, Smith said

Deputy Governor Dave Ramsden told the August press conference that BOE staff consider QT has had only a “modest” 15-25 basis-point impact on term premia, but Smith noted that one of the Bank's own working papers suggests the effect may be more pronounced.

"There's one pretty forensic paper that suggests that the impact of the first 100 billion of QT could have been in itself about 20 basis points," he said in an interview, adding that while QT is not the dominant factor pushing up UK government borrowing costs, it is adding to upward pressure on yields.

Since its commencement in 2022, QT has combined active sales of gilts with passively allowing bonds to mature. The programme has run at GBP100 billion over the last two October-to-September periods, though over the last 12 months active sales have comprised only GBP13 billion of the total with the remaining GBP87 billion coming from maturities.

Over the next 12 months, however, only GB49 billion are due to mature, while the BOE is likely to maintain a roughly steady pace of active sales, reducing the total size of QT to around GBP60 billion. Long-dated gilt sales could be ended completely. (See MNI INTERVIEW:  BOE To Cut Long Gilt Sales - Ex-MPC's Saunders)

RESTORING FISCAL HEADROOM

Smith also commented on the upcoming November budget, saying that Chancellor of the Exchequer Rachel Reeves needs to restore fiscal credibility by increasing her headroom against her balanced-budget rule.

The GBP9 billion in headroom allowed in her past budget was insufficient and should rise to "something that was closer to the average of past chancellors. I think ... you could argue for more, but in the 20 to 30 [billion] range,” he said.

"What we're talking about fundamentally here is tighter fiscal policy ... we see the government is finding it difficult to break down spending, particularly on the welfare side. So you'd have to think the counterpart to that would be more on the tax side, and whether that in itself is feasible, will create a whole other set of ... political issues for the government.”

The National Institute of Economic and Social Research has estimated the government’s financing gap under the current budget rule at GBP41 billion so Reeves would have to tighten fiscal policy by GBP60-billion-plus, or over 2% of GDP, to get inside Smith's range.

"It may be that the Chancellor can't move quickly to a higher level of headroom, but you know the good thing here, which is quite different from recent fiscal tightenings that we have in recent memory, is the Bank of England can cut rates and keep that from slowing the economy to a large degree," he added.

One idea floated in thinktank circles has been for Reeves to bring forward wriggle room allowed under her fiscal rule by a year. The rule states the current budget must be in surplus in 2029-30, until 2029-30 becomes the third year of the forecast, when it allows surpluses or deficits of up to 0.5% of GDP.

Smith said that while that change is "completely feasible,” the government might fear it would misfire.

“I personally think if you look at how the government has reacted and set policy, including at the spring statement, that they are rightly worried that any loosening of the rules or reduction in headroom might be another source of financial market volatility," he said.