There have been some concerns that as well as there being little scope to generate stimulus through interest rate cuts, the Bank of England is now reaching its limits on Quantitative Easing (QE). But the Bank seems open to loosening its own QE rules. And over the next few years, there is likely to be no shortage of gilt issuance. That’s why we think the Bank can be safe in the knowledge that it has more QE headroom to support the economy should it be necessary.
- There have been some concerns that as well as there being little scope to generate stimulus through interest rate cuts, the Bank of England is now reaching its limits on Quantitative Easing (QE). But the Bank seems open to loosening its own QE rules. And over the next few years, there is likely to be no shortage of gilt issuance. That’s why we think the Bank can be safe in the knowledge that it has more QE headroom to support the economy should it be necessary.
- We were right to predict back in June that this year policymakers would do much more to support the economy than others expected. (See here.) The £150bn of QE that the Bank announced in November means that since the start of the COVID-19 crisis, the Bank has increased QE by £450bn. So in ten months it has done more QE than the £445bn in the ten years since the Global Financial Crisis and the Brexit referendum. That takes the total stock of QE to £895bn in total, or £875bn of gilts and £20bn of corporate bonds.
- There are concerns that the Bank’s QE policy is now reaching its limits. According to its self-imposed rules, the Bank cannot buy index-linked gilts, it cannot buy gilts with less than three years’ maturity and it is limited to holding no more than 70% of any specific bond. At face value, that doesn’t leave much space. Of about £2,530bn of outstanding gilts, about £790bn are index-linked gilts and about £300bn are gilts with less than three years’ maturity. That leaves about £1,440bn. 70% of that is £1,010bn. So there may be room to increase QE by only £135bn from the current £875bn. (See Chart 1.)
- But there are three points worth stressing. The first is that the amount of headroom depends on the amount of gilts in issue. As Bank of England Governor Andrew Bailey recently suggested, headroom is a fluid rather than a static concept. And over the next few years, there will be no shortage of gilt issuance. Over the next five years, our central government net cash requirement (CGNCR) forecasts suggest that the government may have to issue a total of £1.25trn of gilts. (See Chart 2.) Of course, the Bank will still be subject to the restrictions above, but that clearly leaves a lot more space.
- The second point to note is that, just like the ECB, the Bank may be willing to change its rules on the quantity and type of assets it can buy and hold. In November 2015, the ECB raised its issue limits from 25% to 33%. When it announced its Pandemic Emergency Purchase Programme (PEPP) in March, it suspended those limits and changed the maturity range for its purchases from 1yr-30yr to 3m-30yr. In a recent speech, MPC member Dave Ramsden suggested that the Bank is open to following in the ECB’s footsteps, noting that “there would be scope to re-evaluate [the constraints] if…headroom was needed”.
- The third point is that, in extreme scenarios, the Bank could purchase a higher share of investment grade corporate bonds or riskier assets, such as non-investment grade bonds or equities, as the Bank of Japan has done. There are reasons in practice, though, why these options might not be that appealing. (See here.)
- Overall, unless a COVID-19 vaccine dramatically improves the economic outlook, we still think that there is plenty of room for the Bank to announce £100bn more QE next year. This doesn’t mean that the Bank will focus on more QE and nothing else. If our economic forecast is right, then it may need to get more imaginative and resort to other tools eventually, such as negative interest rates. But we are not concerned about a lack of space. The bigger question marks are around the effectiveness of more QE.
Chart 1: BoE Stock of Gilt Purchases & Stock of Gilts in Issue (£bn)
Chart 2: Net Gilt Issuance and Central Gov’t Net Cash Requirement (CGNCR) (£bn)
Sources: BoE, Capital Economics
Sources: OBR, Capital Economics
Ruth Gregory, Senior UK Economist, +44 (0)7747 466 451, email@example.com