Is the Bank of England financing the UK government?

Today’s subject does have historical echoes as who can consider this sort of topic without thinking at least once of Weimar Germany with its wheelbarrows full of bank notes and Zimbabwe with its trillion dollar note? These days we need to include Venezuela which cannot even provide a water supply now. There are three good reasons therefore why central bank Governors should tread very carefully around this particular subject. So it was curious to see the Governor of the Bank of England long jump into this particular pit yesterday in a Sky News podcast.

The government would have struggled to fund itself if the Bank of England had not intervened during the market “meltdown” of COVID-19, the Bank’s governor has told Sky News.

In an exclusive interview, Andrew Bailey said that in the early stages of the virus, Britain came within a whisker of not being able to sell its debt – something many would characterise as effective insolvency.

There are elements of the first paragraph which are true but “came within a whisker of not being able to sell its debt” is a curious thing to say and if we are being less kind is in fact outright stupid. We are also guided by Sky News to this.

While there was an uncovered gilt auction in 2009 – in other words, the government was unable to find buyers for all of the debt it was selling to investors – it was widely seen as a one-off.

They are trying to make this sound a big deal but it isn’t really. For example over the past few years I can recall Germany having several uncovered bond or what they call bund auctions. Nobody considered them to be within a whisker of being unable to sell their debt, in fact Germany had a very strong fiscal position. Here as an example id CNBC from the 21st of August last year.

The bund, set to mature in 2050, has a zero coupon, meaning it pays no interest. Germany offered 2 billion euros worth of 30-year bunds, and investors were willing to buy less than half of it, with a yield of minus 0.11%.

What was it about having to pay to own the bond and do so for around 30 years that put investors off? That of course provides the clue here which both Sky and Governor Bailey either have not figured out or are deliberately ignoring. The debt did not sell because of the price at which it was offered was considered too expensive. Germany could have sold its debt if it was willing to pay more,

How did the Bank of England respond?

Mr Bailey warned that the dislocation in markets in March was even more serious, prompting the Bank to intervene with £200bn of quantitative easing – the biggest single cash injection in its history.

Actually it also cut Bank Rate to 0.1% and there is significance in the date which was the 19th of March. That is because the price of our debt was rising which has been summarised by the Governor like this.

The governor said: “We basically had a pretty near meltdown of some of the core financial markets.

“We had a lot of volatility in core markets: the core exchange rate, core government bond markets.

“We were seeing things that were pretty unprecedented, certainly in recent times. And we were facing serious disorder.”

If we look at the UK we were seeing a rise in Gilt yields as the benchmark ten-year yield rose quickly from an all-time low of 0.12% on the 9th of March to 0.87% on the 19th. We have seen much worse in the past and I have worked through some of them! In historical terms we still had very low Gilt yields and so it looks as if we are seeing another case of this from a central bank.

Panic on the streets of London
Panic on the streets of Birmingham
I wonder to myself
Could life ever be sane again? ( The Smiths)

The job of calming down world financial markets was a dollar issue and was dealt with the next day by the US Federal Reserve.

The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank are today announcing a coordinated action to further enhance the provision of liquidity via the standing U.S. dollar liquidity swap line arrangements.

We will never know now how much things would have improved in response to this as a panic stricken Bank of England fired as many weapons as it could. As a technical factor overseas QE bond buying helps other markets via spread and international bond buyers. Whether that would have been enough is a moot point or as central bankers regularly try to point out, the counterfactual! We do know from experience that it is a powerful force exhibited in say Italy which only saw bond yields rise to 3% and that only briefly recently as opposed to 7% last time around.

Anyway even the relatively minor rise in UK Gilt yields has the Governor claiming this.

Asked what would have happened had the Bank not intervened, Mr Bailey said: “I think the prospects would have been very bad. It would have been very serious.

“I think we would have a situation where in the worst element, the government would have struggled to fund itself in the short run.”

Okay so he is in effect claiming to have funded the government although not long afterwards he claims that he is not.

The Bank’s decision to create so much money and use it to buy government bonds, including an extra £100bn only last week, has prompted some to ask whether it is in effect financing the government’s borrowing. Mr Bailey rejected the accusations of “monetary financing”.

“At no point have we thought that our job was just to finance whatever debts the government issue,” he said, pointing out that the objective was to ensure economic stability.

Ah so not inflation targeting then?

Comment

The situation here was explained back in the day in an episode of Yes Prime Minister and the emphasis is mine.

We believe that it is about time that the Bank ( of England) had a Governor who is known to be both intelligent and competent. Although an innovation it should certainly be tried.  ( Treasury Permanent Secretary Sir Frank)

As you can see this was a topic in the 1980s and it still is. The present Governor was in such a rush to indulge in “open mouth operations” to boast about his role in the crisis that he not only overstepped the mark he made some factual errors. The UK government could have funded itself but it would have to have paid more for the debt. It could have activated the Ways and Means account earlier than it did as well if needed ( we looked at this on the 9th of April). So we see several of my themes at play. The Bank of England is implicitly but not explicitly funding the UK government right now just like the Bank of Japan, ECB and US Federal Reserve,something I pointed out on the 6th of April.

Let me finish off on the subject of monetary financing. The simple truth is that we have an implicit form of it right now.

This means that it is about as independent as a poodle (another theme). It tends to panic in a crisis and new Governor’s tend to reward their appointment with an interest-rate cut. I cannot take full credit for the latter as that was in Yes Prime Minister as well.

Also in the podcast was a reference to this.

The governor signalled that the government may need to consider finding a vehicle to resolve the many bad debts left by companies that fail over the COVID-19 period.

“If (a bad bank) were to be contemplated, it would be as a sort of an an asset management vehicle: how do we manage small firms through a problem that they would get as a result of the loans that they’ve taken on to deal with the crisis?”

Somebody needs to tell him the UK taxpayer has one of those and it is called Royal Bank of Scotland with a share price of £1.24 as opposed to the Fiver we “invested” at.

Let me finish by giving Governor Bailey some credit for a burst of much needed honesty.

“We’ve been mis-forecasting the labour market for some time because the traditional models just didn’t seem to hold.

We can add that to his apparent enthusiasm for changing policy on the subject of any QT in a direction I have been recommending since September 2013.

Podcast

 

 

The Bank of England has its Ways and Means

Today my home country the UK is back in the focus of economics and in several ways. The first returns me to my article of Monday when I pointed out this.

Let me finish off on the subject of monetary financing. The simple truth is that we have an implicit form of it right now. Why is the currency not collapsing? Because nearly everyone else is at it too!

This was on my mind this morning as I noted the announcement from the Bank of England although as I looked at the media I also noted that very few had bothered to read the headline and I have emphasised the relevant part.

HM Treasury and the Bank of England (the Bank) have agreed to extend temporarily the use of the government’s long-established Ways and Means (W&M) facility.

Here are a couple of responses who seem to have avoided reading the release.

‘Helicopter money” begins in the UK, the Bank of England will directly pay for government spending WITHOUT government having to issue debt. This will happen everywhere and should happen here in Ireland. Only way to avoid austerity stupidness later. ( David McWilliams)

 

Biggest experiment in monetary history: Bank of England to directly finance extra government spending ( @Schuldensuehner)

No-one seems to have told Holger about Zimbabwe or more curiously Weimar in his home country but he might have held his horses back if he had bothered to read the  actual release rather than the Financial Times click bait twitter headline.

Bank of England to directly finance extra government spending

Ways and Means

This is described below.

The W&M facility is the government’s pre-existing overdraft at the Bank.

This is a little awkward for the takes above and has another irony in that we see some claiming you cannot treat government borrowing like an overdraft when in fact this bit is one! In terms of amounts it existed yesterday.

Ordinarily a standing balance of around £0.4bn is maintained to support Exchequer cash
management…. As of 8 April 2020, drawings under the W&M facility remain at £0.4bn. The outstanding balance will, as normal, be published weekly on the Bank’s website.

Actually it is some £370 million but these days £30 million seems so small doesn’t it?

In terms of what will happen now well it will get larger.

As a temporary measure, this will provide a
short-term source of additional liquidity to the government if needed to smooth its cashflows and support the
orderly functioning of markets, through the period of disruption from Covid-19.

I have pointed out before that this orderly functioning of markets issue is something of a fantasy, after all the Bank of England is like a London Whale in the UK Gilt market. But as long as this is a short-term measure then it is sensible.

Let me explain with reference to the last time this facility was used in size.

The previous high for use of the W&M account was £19.9bn in 2008.

This was from Christmas Eve 2008 until the 25th of February 2009 when it fell to £4.14 billion and then to the overdraft level of £370 million on the 8th of April. As to the details well it was hard not to have a wry smile when I noted it was Robert Pearson who asked for them via a Freedom of Information request so let me show the relevant part of the reply.

The Government repaid £7.0 billion of the Ways and Means Advance on 17 April 2008. It subsequently decided to increase the balance of the Ways and Means Advance temporarily, by £3.8 billion, in order to smooth the impact of the refinancing of part of the Bank of England’s loan to the Financial Services Compensation
Scheme. The Government will repay the remaining £3.8 billion in 2009-10.

We are told that this will happen again this time around.

. Any drawings will be repaid as soon
as possible before the end of the year.

Quantitative Easing

Rather curiously the financial section of UK social media seem much less interested in the £200 billion of UK QE that has been announced. The UK issued  a  £3.25 billion of Gilt earlier this week and this led to more than a few reports that we were finding it easy to issue our debt. Whilst this is true it is surely relevant that the Bank of England bought some £4,5 billion of Gilts on the same day. That will happen again today meaning that a total of £13.5 billion will be bought this week.

If we stay with the QE purchases then we have bought out as far as 2071 ( QE for our grandchildren) and paid as much as £221.8 for something which will be redeemed at £100. That is a sign of how much Gilt yields have fallen because believe it or not the 2068 Gilt offers a coupon of 3.5% whereas we would now offer a coupon of 0.75%. Actually you might make a case for 0.5% but I think you get the idea.

UK Net Debt Issuance

In spite of a large amount of Gilt issuance this week by the UK government which is £12.21 billion by my maths if we allow for the Bank of England purchases we remain net buyers of the order of £1.3 billion. This seems likely to continue as this excerpt from a twitter conversation with the Gilt trade Moyeen Islam shows.

At 13.5bn a week, APF will outstrip supply and see 25bn returned in cash terms to the mkt over April.

Mortgages

There is a curious state of play right now. In the opinion of the Bank of England a major factor in its impact on the economy is via the housing market and house prices. These days that is more via QE and the Term Funding Scheme than official interest-rates because so many mortgages now have a fixed interest-rate.

LONDON (Reuters) – Britain’s housing market has been thrown into the deep freeze by measures to slow the spread of the coronavirus, and is unlikely to have recovered a year from now, according to the Royal Institution of Chartered Surveyors.

Actually when making the point I got this reply from Andy Barnes.

Indeed! If you’re after a 10 year fix as a FTB with less than 40% deposit (quite likely), then you have a grand total of just 2 mortgage products (HSBC) to choose from on the market. Min 20% deposit, relatively extortionate rates of 3.19% and 3.44%.

 

Comment

A calm analysis of the Bank of England action shows that today’s move is not as so many have broadcast. This does not mean that there are no challenges. For example we have seen the word “temporary” used and regularly abused in the credit crunch crisis. So much so that it is defined as “any time between now and the end of the universe” in my financial lexicon for these times. However the UK government is plainly spending at a very fast rate and it will take a while to issue the Gilts to pay for it. Otherwise the market may get indigestion in spite of all the Bank of England purchases. So for once there is some truth in this being to help create an orderly market.

The bigger danger to my mind is the amount of QE  that is being undertaken as we head for £645 billion. There are loads of takes that this is fine and for now it is. But should we ever recover we will have an expanded money supply with velocity picking up and there will be inflation dangers. Not now because even with money there is not a lot to spend it on! But it may happen sooner than we might think.

On the subject of inflation the UK has a new measure and I have formally replied to it.

Movements in the all-HDP items index show a stable increase over time, with an increase of 2.6% since week 1.

Anyway here are part of my thoughts and the full reply is on the Statsusernet website.

I can give an example of an issue here which is valid as this is essentially an anecdote index. In terms of Rice there was a sustained period when the shelves were empty of it and best of luck with getting an online shopping booking! Anyway when I could buy some I had to buy a different type which was some 73% more expensive. Also as I liked the Rice I previously bought I may have been substituting an inferior product making the change larger. So there was quite a shift which I am sure many experienced……….

Accordingly there is much to consider in terms of both the new measure and keeping the normal measures of inflation relevant. In that spirit may I suggest that the indicator saying Antibacterial Cleansing Wipes fell in price in the first week of the measure gets looked at again as the seems to quote the film Star Wars to be from a place “far,far,away…”

Let me finish with some good news which is that UK banks seem to have their US Dollar liabilities under at least some control, which is not true everywhere.

BoE: Allots GBP5 Mln At Contingent Term Repo Facility 3-Month Operation, Zero At 1-Month Operation