Lessons from the Bank of England’s QE programme
Letter writing, accountability and a postmortem of QE
A recent blog post by David Aikman, director of the National Institute of Economic and Social Research, asks whether the current system for holding the Bank of England’s accountable is good enough. Letters explaining inflation misses have lost their bite. And the Bank falls behind international best practice in conducting periodic independent reviews, something Dr Aikman calls “formal postmortems”.
The 2023 Bernanke Review was a rare example of an independent, well-resourced, critique. It could — and should — be the first of many. Because the Bank’s quantitative easing programme clearly demands such treatment. What might a postmortem teach us? From our dual perspectives, eight lessons jump out.
During the QE era
(1) Don’t take extra interest rate risk when you do not have to
With certain gilts showing losses of 70 per cent or more to the Bank, probably the most important lesson is not to take more interest rate risk than you need. Yes, the gilt curve is naturally longer dated. But buying longer dated gilts is a choice. Certain other central banks such as the Reserve Bank of Australia confined their QE to particular maturities, partly because of that risk.
Explicitly not taking into account financial risk is not a good look for an organisation charged with prudential risk management.
(2) Tailor your QE to your domestic credit channels
A good reason to avoid long-dated bonds comes from the unusually short-term nature of the household borrowings in the UK (think 2-5 year fixed rate mortgages rather than 30 year in the US).
In the UK, you will get more QE bang-per-buck from the front end.
(3) It is OK for central banks to notice and respond to their yield curves
Targeting QE in this way implies taking a greater interest in the shape of the yield curve. The BoE should not be troubled by this.
The Federal Reserve provides an example. During Operation Twist it tackled long dated yields. Later, during the pandemic, it focused disproportionality on short dated securities.
By contrast, the BoE’s “equal focus along the curve” meant continuing to buy ultra long dated gilts in 2021 / 2022 — after that part of the curve had inverted. When long dated gilts yielded less than other parts of the curve, a nimbler approach could have refocused QE, both to improve policy effectiveness and lower financial risk.
(4) There are things to buy other than nominal government bonds
The BoE QE programme was notable for being more concentrated into conventional government bonds with fewer other assets. In contrast to the Fed, it held no inflation protected bonds. And its credit programme was far smaller, with only 2% of its balance sheet in corporate bonds, and less flexible. So the BoE largely passed up the opportunity to help bring down spreads or to hedge an element of the inflation risk. Again, these choices could be reviewed.
During the QT era
(1) Be curious why other central banks are not copying you
If active QT is such a good idea, perhaps ponder why few central banks are doing it. Consider slowing the aggregate pace (active plus passive) to match the peer group.
(2) Pay heed to market feedback
Investors had long warned the Bank about the impact from a gilt sales programme. Back in September 2022, before active QT had begun, a BoE survey showed investors estimated the BoE’s plans to sell gilts had already moved long-dated gilt yields up by 15 bps, and would go up a further 10 bps (ie totalling 25 bps) as those plans were implemented.
That was the last time the Bank formally surveyed investors for their opinion.
A year later, the Bank was claiming a smaller impact of “less than 10 basis points”. It did not acknowledge that September 2022 investor feedback in their formal write-up and only quoted from earlier surveys taken at a time when the full scale of QT was unknown.
A review could look at the degree to which the Bank should incorporate investor perspectives.
(3) Be more open minded about the impact your actions are having
When high profile research, led by an ex-MPC member, estimates that QT is moving gilt yields by up to 70bps, 3-4x more than the BoE’s own view, avoid claiming this is “broadly consistent” with the Bank’s own analysis.
Don’t risk another rebuke from the House of Lords for a biased assessment. Don’t lean too heavily on US-focused research — where no active QT is taking place. Instead, look around for UK focused research. For example, our own separate academic and investor-based assessments puts the BoE QT impact on yields at around 35-40bps.
If the BoE view is incomplete, reconsider and adjust course.
(4) Finally, do not lock yourself in for a year at a time
The QE announced in November 2020 locked the Bank into bond purchases until December 2021. Yet by May 2021, CPI inflation was above target. By August 2021 CPI was 3.2 per cent. Still the QE programme rolled on. Predictability is all well and good, but it can stray into inflexibility.
More recently, in April, the BoE commendably cancelled some gilt sales due to market pressure. When the postponed auctions resumed in July, prevailing yield levels were almost identical. Again, this could be seen as dogma, rather than market savvy.
So, avoid the “high bar to change course” language. Do not overcommit. Give yourself optionality to review as you go. Today, an active sales programme totalling some £127bn deserves to be looked at in detail more than once a year, in the September MPC meetings.
Looking forward
QE was not plain sailing, especially for the BoE. In the UK mark-to-market losses are over 5 per cent of GDP — around 4x greater than comparable costs in the US. Today, active QT leaves the Bank accused of placing unnecessary strain on Britain’s government debt. These issues are not addressed in the Bank’s latest attempt to scrutinise QE. There is little in the way of lessons learned or admissions of mistakes.
No QE/QT programme will be perfect. And likewise, some feedback will resonate more than others. But let us try to learn from the past, not gloss over it.