The new Bank of England QE program explained

Today brings us quite a bit of new information on the state of play of the UK economy post the Brexit leave vote and the Bank of England response to it. It is a rather moot point that the Bank of England should have waited for such data before pressing the trigger on its monetary sledgehammer. After all it may yet crack the wrong nut! Let me start with what we have discovered about the new Bank of England QE (Quantitative Easing) machine which fired up its new engines yesterday. Just as a reminder I pointed out on August 5th that the salvo of £70 billion ( including £10 billion of Corporate Bonds) may well have been fired straight into the nearest foot.

The deficit of defined benefit pensions, which pay out an income linked to an employee’s final salary, jumped £70bn as a direct consequence of the decision to reduce interest rates by 0.25 per cent, according to Hymans Robertson, the consultancy.

Ah so a one for one ratio with the planned QE increase! At this point Mark Carney and the Bank of England are wearing a collective Dunces cap. Let us move onto the technical details of the new QE era. Back in 2012 the Bank of England reported on another issue

that would give an estimate of the total increase in household wealth stemming from the Bank’s £325 billion of asset purchases up to May 2012 of just over £600 billion, equivalent to around £10,000 per person if assets were evenly distributed across the population.

Apart from an implicit confession that it is aiming at equity and house prices the obvious catch is that the assets are not “evenly distributed” as they are concentrated in much fewer hands as the echoes of the 1% and 0.1% appear. Or to be put another way.

And the survey suggested that the median household held only around £1,500 of gross assets,

The Purchases

This will be made on a Monday, Tuesday and Wednesday at which point the Bank of England’s presumably exhausted bond buyers will retire for the next four days. Each day they will do this.

Between 8 August 2016 and 31 October 2016, the size of auctions will initially be £1,170mn for each maturity sector.

They buy a particular part of the maturity spectrum on a particular day so today Tuesday is for long-dated Gilts.

The Bank will continue, normally, to conduct three auctions a week: gilts with a residual maturity of 3-7 years will be purchased on Mondays; of over 15 years on Tuesdays; and of 7-15 years on Wednesdays.

Tuesday’s are particularly significant as they are the day that not only our children are committed to the consequences of QE but our grandchildren as well. The category “over 15 years” includes our longest-dated UK Gilt which matures in 2068 and as part of previous operations the Bank of England owns some £989 million of it.

As the size of the operation increases then this factor will become more significant.

The Bank does not currently intend to purchase gilts where the Bank holds more than 70% of the “free float”, i.e. the total amount in issue minus government holdings. The Bank will, however, continue to keep the gilts eligible for purchase by the APF under review.

The consequences

These are to be seen in UK Gilt prices which are surging and consequently in yields which are falling. The benchmark ten-year yield has fallen below 0.6% this morning for the first time ever and the thirty-year yield has fallen to yet another new low of 1.41%. Of course the latter will be seeing Bank of England purchases today as it buys the highest Gilt prices we have ever seen.

Those who have the ability to remortgage might well be noting that the UK five-year Gilt yield is a mere 0.17% as that particular rate is used for the various derivatives used to set the rates for fixed-rate mortgages. So there could be a bonanza set of offers to come unless of course the banks suck the gains into their margins.

Differences with the ECB

Yesterday showed up a couple so let me explain. The ECB will not buy bonds yielding less than its deposit rate currently -0.4%. Whereas the Bank of England bought a 2019 Gilt yielding a mere 0.03% proving that it is quite content to buy UK Gilts at a yield much lower than its Bank Rate of 0.25%. As it finances its purchases at Bank Rate it may lead to some head-scratching however! Perhaps nobody has thought that through yet.

But the concept of a 0% or even negative yield does seem to put the Bank of England off as there were offers for Gilts around that area it rejected and I suspect that the cause was along those lines. We will have to wait and see as this will not recur until next Monday.

Index-Linkers

Just for clarity the Bank of England does not buy these as part of its QE operations so around 22% of the UK Gilt market is not available to it. It has of course purchased then in the past for its pension fund.

Today’s data

This opened with the most timely in the series from the British Retail Consortium. From Reuters.

Retail spending in July was 1.9 percent higher than a year earlier, the biggest rise in six months and up sharply from 0.2 percent growth in June, when bad weather added to uncertainty around June 23’s referendum, the British Retail Consortium said.

This news added to yesterday’s.

The data are in line with figures on Monday from credit card company Visa which showed consumer spending picked up in July, as Britons’ behaviour failed to match a post-Brexit slump in sentiment reported in earlier surveys.

So we should note that the BRC numbers do not always coincide with the official data and single month retail sales figures are unreliable but so far so good especially compared to the worst fears. It adds to the positive tourism figures reported yesterday.

Next up came some solid production data although it was for June so maybe only slightly affected by the Brexit result.

Total production output is estimated to have increased by 0.1% in June 2016 compared with May 2016……..Total production output is estimated to have increased by 2.1% between Quarter 1 (Jan to Mar) 2016 and Quarter 2 (Apr to Jun) 2016.

So month on month positive albeit by the smallest margin but the quarterly data was reviewed like this by Andy Verity of the BBC.

Industrial output grew in the second quarter of the year faster than it had since 1999 (ONS).

A little care is needed as the boost was earlier in the quarter and may have been affected by the Easter seasonal adjustment misfiring but still good.

Manufacturing was down on the month by 0.3% but overall had a good quarter.

The largest contribution to the quarterly increase in total production came from manufacturing, which increased by 1.8%. The largest contribution to the increase in manufacturing came from the manufacture of transport equipment, which increased by 5.6%.

I have highlighted the transport sector because it was it after a good quarter which was the main player in June manufacturing dipping.

Trade problems

These are ongoing for the UK economy and I have been writing about them for years and years. As the monthly figures are pretty hopeless as for example the important services data is only collected quarterly here is the state of play.

Between Quarter 1 (January to March) 2016 and Quarter 2 (April to June) 2016, the total trade deficit for goods and services widened by £0.4 billion to £12.5 billion.

Persistent deficits are the name of the game here. How much of a difference the lower UK Pound will make is open to speculation although some sections of the Financial Times appear to believe it should have been affecting the trade figures before it had happened?! Perhaps they have been watching too many time travel episodes of Dr.Who.

Comment

There is something of an irony in that as I look through and analyse the new QE operations of the Bank of England program that today’s evidence suggests it is not necessary. There are always dangers in any data series but retail sales and production (albeit modestly) being higher do not a case for QE make. If QE helped a trade position then we should have started it some 20 years or more ago!

Yet the siren voices at the Bank of England cry out again. From Reuters.

“Bank rate can be cut further, closer to zero, and quantitative easing can be stepped up”, McCafferty wrote in an op-ed for the Times.

Has Ian McCafferty forgotten already that he voted against the extra QE? No doubt he hopes people will forget how his votes for an interest-rate rise turned into the reality of an interest-rate cut. He must be dizzy from all the U-Turns and spinning around.

 

 

 

 

 

 

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18 thoughts on “The new Bank of England QE program explained

  1. Shaun, since your last post on this topic I have tried to find the economic disaster that warrants such an extreme move by the BofE and I just cant see the justification for their action. Even the CBI appears puzzled by what they have done. Central banks appear to be over reacting to the slightest bit of bad news these days and are unable to accept that economies have flat spots, dips and periods of growth – that’s just they way it is and the way it will always be. They are going to have egg on their faces if in a few months time the Brexit big slump turns out to have been a myth although no doubt will claim that their early action has saved the day – having said in the past that it takes years to come to work through the system. The best thing they could have done was to play down the consequences of Brexit (if any), be more optimistic and drop the doom and gloom pronouncements and keep their powder dry for future problems. I can only assume they have access to data that I do not however much of my feedback has been from the coalface so to speak.
    I really am baffled.

    • your baffled ?

      how do you think Bagdad Carney feels ?

      as the results come out and the recession dissappears , he’ll need some good excuses …….

      Forbin

      ” His lunatic counterfactual art is more appealing than the banal awfulness of the (un) Reliable MSM .

      He stands superior to truth.”

  2. I agree with Pavlaki, it seems the Governor has access to information that no one else has and that is not suggested by the data. Is it pre-emptive cash flow support for the banks ready for when one of the Italian banks goes under? Otherise, I can’t see any rational for a cut and, personally, would like to see a very gradual increase back towards ‘normality’.

    Thanks for the excellent reporting Shaun. It was you, I think, who pointed out that negative rates in Europe caused banks to increase borrowing rates to replace the profits previously made on oevrnight deposits at the central bank so we’ll have to wait and see what happens here.

    • Yes, but they had to be to seen be doing something and that was what every other CB has done, whether it was needed, appropriate, or timely.
      The great thing with the Bof E they are dependable – dependable to do the wrong thing at the wrong time, offer the wrong advice and make the wrong predictions!
      If you do or think the opposite to them, you can’t go far wrong.

  3. On a side note I read that Lionel Barber, the editor of the FT, has just received the Legion d’Honneur for the FT’s ‘positive role in European debate’ on Brexit. Evidently he tweeted it by mistake.
    I suspect Carney will be receiving the same reward soon!

    • Hi Bez

      Well the FT certainly has had a “positive role in the European debate” from the point of view of Europe. I took a check at the way it was releasing the production data and this is how they reviewed overall being up but manufacturing slipping.

      “fastFT ‏@fastFT 12h12 hours ago
      UK manufacturing production continued to shrink in June http://on.ft.com/2bb6BWv

      I gather there are grades of award and this was only a minor one which would be far too minor for Governor Carney I would suspect.

  4. Hi Shaun
    Stats that show the BoE’s actions had little or nothing to do with the ‘real economy’, but a lot to do with further propping up of the commercial banks and as a convenient byproduct enhancing asset values for the very rich, and of course ‘proving’ how their dire Brexit advice was on the money. Plus ça change, plus c’est la même chose.
    Hand over the sick bag…

    • people keep thinking its the economy

      but the only economy the BoE cares for is the pension schemes and lucrative jobs in the Banking sector

      Chums again after more public largess stuffed into their greasy hands…..

      forbin

  5. Very good summary of the data and sound analysis. Since then niesr have come out with a measure of contraction of output in july but still not a recession for may to july. But they are projecting q3 to be negative. I just don’t get it in the light of the data.

    • Hi am and thanks

      For those who have not read the NIESR GDP report here is the meat of it.

      ““We estimate that in the three months to July the UK economy grew by 0.3 per cent, a marked economic slowdown. The month on month profile, suggests that the third quarter has got off to a weak start, with output declining in July.”

      Okay so a weak July and to be fair their record of telling us what has just happened has been good recently. But like the rest of us they do not yet know what the whole quarter will bring.

  6. Has Ian McCafferty forgotten already that he voted against the extra QE?

    He’s outwardly respectable. (They say he cheats at cards.)
    And his footprints are not found in any file of Scotland Yard’s
    And when the larder’s looted, or the jewel-case is rifled,
    Or when the milk is missing, or another Peke’s been stifled,
    Or the greenhouse glass is broken, and the trellis past repair
    Ay, there’s the wonder of the thing!

    McCafferty s not there!

    hehe

    forbin

    • Hi Forbin

      So Ian McCafferty is now the “Spinning Wheel” at the Bank of England now that Martin Weale has left. Only a few days after voting against more QE “Kristin Forbes, Ian McCafferty and Martin Weale voted against the proposition, preferring no additional purchases at this time.” He now says

      “”If the economy proves to have turned down in line with the initial survey signals, I believe that more easing is likely to be required, but that can easily be delivered in coming months,” ”

      Frankly his message looks confused because he is…

  7. in other news

    The European Union has formally agreed to waive fines for Spain and Portugal over their excessive budget deficits.

    well whoda thunk it?

    Forbin

    • Yes totally predictable. The EU sets up rules, everyone breaks them at some point but each time it’s exceptional circumstances. It only increases my contempt for the whole set up.

  8. Shaun, apparently this policy has already failed. The Govt could not purchase the bonds at the maturities they desired. The Insurance and Pensions industry wouldn’t sell them! What a Carney Circus fiasco this is, I read a cyncial comment yesterday… We have a Govt that hides behind the advice of bankers. Wholly appropriate me thinks .

  9. Hi Shaun,
    Great stuff. I hope it’s very widely read.
    “A group of people in a dark room….” comes to mind again.
    i see this blog entry gets a mention in the Guardian. Good!

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