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CENTRAL banks are about to start withdrawing the stimulus they’ve pumped into their economies by buying bonds.
For the Bank of England (BoE) in particular, reducing its balance sheet while simultaneously raising interest rates takes monetary policy into uncharted territory.
Policy makers could quickly find themselves in the crosshairs, blamed for exacerbating the economic slowdown they’ve forecast.
The UK central bank, already well into its interest-rate hiking cycle, is about to accelerate the contraction of its £863bil (RM4.7 trillion) quantitative-easing (QE) portfolio.
In March, it stopped reinvesting maturing debt.
After its Sept 15 policy meeting, it plans to start selling gilts into the secondary market.
The trouble is, because the past 13 years have seen nothing but more and more QE.
The first was in the wake of the global financial crisis and then to keep growth alive during the pandemic.
Nobody knows the economic impact of taking away £80bil (RM433bil) of central bank liquidity annually.
The BoE has been very careful to draw a distinction between its main policy tool of interest rates, and this supplementary measure of so-called quantitative tightening (QT).
While it says it doesn’t expect QT to have much influence on monetary conditions, in reality it’s guessing.,
If liquidity in the banking system dries up, this could very easily become a political football.
These are dangerous waters: the Federal Reserve’s (Fed) first two attempts at QT had to be stopped and, ultimately, reversed.
How smoothly the BoE can run down its balance sheet without provoking a bond-market tantrum remains to be seen.
This is especially so since the Fed is also trying to offload US$95bil (RM422bil) a month from its US$9 trillion (RM40 trillion) balance sheet.
One thing for sure is that getting central bankers to put a number on the effect of unwinding their bond holdings, in equivalent terms to a change in official interest rates, has proved elusive.
The most specific QE calculation came from former BoE governor Mark Carney.
In a January 2020 speech, he said the central bank estimated that every £25bil (RM135bil) of bond purchases had the same affect as 25 basis points of rate cuts.
Fed chair Jerome Powell, at his May 4 press conference, estimated that US$1 trillion (RM4.44 trillion) of QT equates to a single 25 basis-point rate hike.
That disparity speaks volumes about the slipperiness of the prognosis.
The BoE will also dispose of its £19bil (RM103bil) of corporate bonds by April 2024.
That may not sound much compared to the enormity of the BoE’s gilt holdings, but it may cause aftershocks in the sterling investment-grade credit market, as that equates to two-thirds of the annual volume of corporate new issues.