As the Bank of England ends its Quantitative Easing programme today, where has it left us?

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.

To this

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…..

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9 thoughts on “As the Bank of England ends its Quantitative Easing programme today, where has it left us?

  1. hello shaun,

    well what a fix for GDP !! whats it like compared with 2005 index ?

    is it no wonder the people think their politicians are crooks?

    actually I doubt that any noticed as most are fixated on X factor and other mind washing trash ….

    have a look here at Dilbert

    http://www.dilbert.com/strips/2012-10-21/

    ok the bit about “cloudwashing ” could be translated to “GDP-washing ” but its the line about dumb and smart people that got me and brings to mind with what our un & elected leaders are doing !

    carry profit ! isn’t that “money for nothing and your checks for free ” ? dire straits – actually the band’s name sums it up for most of us!

    Forbin,

    PS: I really take my hat off to our leaders , they’ve got this coverup lark all stitch up and tight – now much inflation and poverty will the Brits take ?? plenty is my wager !

    • Hi Forbin

      If we look back and compare the last quarter (Q3 of 2012) on a like for like basis with Q3 in 2005 as in preliminary estimates then we have grown from £348.12 billion to £361.05 billion. That is around 3.7%. I bet if we could go back in HG Wells Time Machine and ask for forecasts then we would at least get a wry laugh…

      Thanks for the cartoon link I can see that it has attracted a fair bit of interest.

  2. It is a perfect scam as no-one even discusses it on most TV programmes/newspapers.
    If a private company rigged a market like this, the directors would go to Gaol.

    • Hi James

      As well as today’s blog I also put out a few tweets that today was the last day of the current phase of the Bank of England’s current QE operations. As far as I can tell declaring that today was a one Shaun operation. So it would appear that to the mainstream media it has become something of a non-subject.

  3. Hi Shaun,

    Another very interesting piece of analysis.

    Presumably the capital risk on the coupon price will be fixed if they keep the gilts to maturity. But as they have paid over 100 what will the overall loss on the £375bn be and how will the interest paid offset this?

    “Our children and grandchildren are unlikely to be thanking us for that one.” As 2060 is 48 years away, UK citizens with children and grand children will have great grand children and great great grand children who will not be thanking them!

    As the short dated bonds reach maturity, I’m sure with little growth that there will be pressure, to continue a trickle feed of QE to replace the maturing bonds, so the liquidity is kept within the system.

    Once we have a Sterling crisis and they use masses amounts of QE to keep bond interest rates down in a fixed market, what will they do once they run out of bonds to buy?

    It is interesting that a think tank today has suggested that they think the 13.3% drop in real earnings today will still be there to a degree in 2020 with the average family still £800 worse off. These days I normally take predictions by economists with a pinch of salt, but with the steady decline of the EU countries in the world economic order, an aging population and ever rising taxes, deficits and debt interest to pay this wouldn’t surprise me.

    I see the Portuguese Government have just pushed through, their parliament, their latest economic suicide note, sorry austerity measures. How is this with further declines in GDP meant to improve their GDP to debt ratio? Now we know that for every 1% rise in taxes will knock 1 to 2% of GDP, why haven’t the sheep, sorry politicians woken up to the fact, where most European countries are over taxed, that they need to re-balance their economies from the public to the private sector and get growth, to reduce deficits and GDP to debt ratios? With those in the Eurozone at the wrong rate, also releasing these shackles? I’m sure their great grand children and great great grand children won’t be tanking them either, with how long it is going to take these countries to recover!

    • Hi rods

      I saw references to that report and it immediately made me think that they were copying one of JWs themes. I hope JW got a fee for the idea!

      As to a recovery in one of the troubled Euro area countries there is little sign so far. Ireland has done the best but she has more austerity to come and a lot is being gambled on hopes for a change on the promissory notes ruling. As for the rest there is more and more economic decline. Odd that suddenly rescue means decline is it not?

  4. answer to Rods2

    the issue is this – there will be no recovery , atleast of any meaningful kind ( 0-1% results are not a recovery at all – needful of 3-5% and that’s unlikely)

    some Gerry Mandered results will flow in once in a while

    today the Greek situation worsened a degree and will continue to do so like Portugal and Spain and Italy

    your comment on ” or every 1% rise in taxes will knock 1 to 2% of GDP,” is missing the boundaries – when do you expect that formula to break down ? Sweden does quite well thank you very much on a higher tax take you know.

    100% tax take – no economy ?

    0% tax take – Somalia style

    I like paying taxes – I buy civilization with it – of course I want value for money ….

    remember Iceland ? they solved their crisis and put bankers on charges as well

    Greece, Portugal and Spain should follow suit

    Forbin

    popcorn supplies are still healthy ;-)

  5. I had a great idea some four years ago but probably a naive idea.

    It went like this:

    Following the first G20 in London we saved the world from a second Great Depression by introducing coordinated interest rate cuts. We could all cut interest rates significantly if we all cut together.

    Since QE was described as an extension of interest rate cutting my idea was that the G20 central bankers introduce coordinated QE and then meet three months down the line, put their neagtive chips on the table and decide how many they can put in the bin.

    Countries in debt would have less debt and those with sovereign wealth funds would have a windfall which they could spend buying bluechip assets in the West.

    I got two comments and both said “Fiat money”.

    There has,however, been some coordinated QE in the meantime.

    • And even more debasement of fiat money as a result. That is always the problem with debasement. It solves the immediate political problem but causes everything, including what governments spend on, to increase significantly in price as a direct result. Governments then need even more money just to maintain their existing expenditure, so guess what: they carry on with debasement which becomes like an addictive drug. It also destroys industry and the real wealth creating processes in an economy. This means there are then less enterprises and employed people contributing to taxes, so the government gets even less revenue. It is thus a very foolish idea and therefore only short-term idiot politicians would even consider such a foolish idea.

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