Today is the last day of the current programme of Quantitative Easing in the UK as the Bank of England will achieve its £375 billion target. Around half past two this afternoon it will purchase £1 billion of UK Gilts (government bonds) in the 2020 to 2025 maturity range. On Monday and Tuesday it purchased £1.1 billion each day to round off the numbers so that the £375 billion target was hit. This has many implications for the UK economy as £375 billion pounds of liquidity/cash has been created by the Bank of England so it can purchase some £375 billion of UK government bonds from the UK Treasury.
The programme began in March 2009 so has been in existence for just over 3 and a half years and has been modified and expanded ( fulfilling my More,More More theme) along the way. I will let the Bank of England explain how.
Between March and November 2009, the MPC authorised the purchase of £200 billion worth of assets, mostly UK Government debt or “gilts”. The MPC voted to begin further purchases of £75 billion in October 2011 and, subsequently, at its meeting in February 2012 the Committee decided to buy an additional £50 bn. In July the MPC announced the purchase of a
further £50bn to bring total assets purchases to £375 bn.
The impact on the UK Gilt Market
As of the latest quarterly update the UK Gilt market had a net nominal size or amount issued of £1070 billion. I am using the word net as these are the holdings after allowing for Gilts held by the Debt Management Office. However this is not the amount that we need to compare with the purchases by the Bank of England as it pays market prices and at this time the UK Gilt market if we take it as a whole is trading above the prices at which it was issued. If you hear or read the phrase “bull market for government bonds” then this is a way of measuring this. I have also suggested more than once that there are dangers of yet another financial bubble building here.
So the net market value of £1297 billion is a better number to use if we wish to compare with Bank of England purchases. So we could say that it now owns about 29% of the UK Gilt market. Let’s say a bit less than that now if we allow for issuance since June.
However the Bank of England does not buy index-linked Gilts
The UK Treasury issues a substantial portion of its debt in the form of index-linked Gilts which as they are linked to the Retail Price Index provide a form of inflation protection. A substantial sum of these has been issued and the market value of these was £333 billion at the end of June. At the beginning it was not clear if the Bank of England would buy these but as you can see below the position them became clear.
The Bank does not currently intend to purchase index-linked gilts
They have been quiet as to why not.Personally I feel that driving up this particular asset price has the issue of raising measures of expected inflation which is obviously awkward for the Bank of England. Perhaps also they do not want to be seen to be driving up the price of the main asset in their pension fund. For those unaware of thsi situation the Bank of England has its own pension fund virtually entirely invested in index-linked Gilts which gives some perspective to the phrase put your money where you mouth is.
However index-linked Gilts have probably seen their prices pushed higher anyway as QE has progressed as an indirect response to purchases of ordinary or conventional Gilts.
So actually the relevant percentage is higher
If we recalculate the numbers above excluding index-linked Gilts we now find ourselves dividing £964 billion by £375 billion or just under 39%.
You can see why the rules were changed
As the relative size of its holdings were changed the Bank of England relaxed its criteria. From.
Conventional bonds likely to constitute the majority of purchases, restricted to bonds with residual maturity between 5 and 25 years.
that the buying range will be extended to gilts with a residual maturity greater than three years
You may note the hint in the initial note that index-linked Gilts would be bought. But the increased size of purchases meant that a relaxation was necessary which had consequences. Let me highlight the first using the Bank of England’s own words.
Given the shortest residual maturity of gilts purchased was three years, the earliest redemption is not until 2013
Yes next year they have to do something! This explains the recent flurry of suggestions as to what to do on this subject which has replaced an intellectual vacuum. This can be represented by this from the Glam rock group Sweet.
We just haven’t got a clue what to do
Also if we look at the other end of the maturity spectrum we see that the Bank of England more recently began purchases of our longer-dated Gilts. We now own some £6.68 billion of our longest dated one which matures in 2060 and we have been paying way over 100 or par for it. Our children and grandchildren are unlikely to be thanking us for that one. We last bought some at a price of 118 compared to a par value of 100 which is food for thought for our descendants and for those talking of “profits” from the programme.
Is there a “pot of gold” at the end of the rainbow
Recently I saw Paul Mason on the BBC’s Newsnight programme say that there was £25 billion available here. I contacted him to say that this was misleading in my view and he replied that he had said that he had there was “talk” of this not actually said it himself. So let us address the issue. The Bank of England subsidiary which holds the Gilts had £20.7 billion in cash as of its latest published accounts.
How? The coupon payments on the Gilts exceed the 0.5% or base rate it is charged for the funds so it makes a carry profit which is building.
The catch is just like the currency carry trades I have described for the Swiss Franc and the Yen you also have a capital risk. As the capital is £375 billion you can see that there is a substantial risk where £20.7 billion represents a 5.5% swing which does not sound a lot put like that.
Just to be clear I am not intervening in the likely political debate over whether the money should be spent. I am saying that it could be spent but it would represent a risky trade. We know what happens when these things go wrong after all where are all those who told us we would make a profit from our holdings in Lloyds TSB and Royal Bank of Scotland?
Has QE done any good?
The Bank of England claims so
Allowing for reasonable uncertainty about the initial impact on asset prices, the result of these sorts of calculations would suggest a peak impact on the level of real GDP of between 1.5% and 2%.
As it published this before the latest increases to the amount of QE then let me say that the same logic leads you to calculating an impact of 3 to 3.5% of real GDP now.
Mind you the Bank of England does not always seem clear
We do get certainty from some.
The evidence suggests that QE has worked
But much less so from others
And I certainly wouldn’t want to suggest that we know with any precision how big the impact from our asset purchases will be.
Meanwhile in the real world
Rather conveniently the UK GDP figures were rebased at 100 in 2009 which is when QE began. As of the latest numbers from last week we are now at the giddy heights of 103.
So for QE to have had the impact claimed by the Bank of England we would have had to have no economic growth at all for three and a half years from any other source. I will leave it to readers to decide for themselves how likely they think that actually is…..