BOE Should Pause Rate Hikes, Sell Bonds Instead: Marcus Ashworth

Last week’s central banker symposium at the International Monetary Fund in Washington was a festival of hawkishness, with one notable exception: Bank of England Governor Andrew Bailey was far more circumspect than his peers at the Federal Reserve and even the European Central Bank in detailing the tricky balancing act between curbing inflation and sustaining economic growth.

And for good reason. The U.K. faces the “worst of all worlds” on rising prices, according to Alfred Kammer, the IMF’s European director. Britain is suffering from a super-hot labor market akin to what’s happening in the U.S., as well as the runaway energy prices plaguing Europe. As a result, the IMF expects U.K. inflation to remain stuck above 5% next year, when other G7 countries will have returned to their 2% targets. At the same time, it expects the U.K. to fall to the bottom of the G7 league table for growth. Stagflation is a real and present danger.

Moreover, there’s a third element unique to Britain among the major economies. The Treasury seems determined to introduce fiscal tightening at the same time as its central bank is reining back on monetary stimulus. The pound has declined against the dollar to lows not seen since the early throes of the pandemic.

This trilemma poses a particularly difficult choice for the BOE. While it’s ahead of both the Fed and ECB in lifting interest rates, it is rapidly running out of hiking road before it risks tipping the economy into recession. The consumer has hit a brick wall with the latest retail sales and confidence data plunging at paces not even seen during the Covid lockdowns. Nonetheless, Chancellor of the Exchequer Rishi Sunak is increasing taxes on both on employees and employers this month, at the same time as energy prices for households are set to surge.

But with inflation already at 7% and looking headed into double digits, the BOE has to keep its inflation fight alive or further endanger its already faltering credibility. It’s time for a change in tactics.

The Monetary Policy Committee will most likely still raise the official bank rate to 1% at its May 5 meeting, its fourth consecutive hike. That’s the threshold where the central bank has said it will “consider” introducing quantitative tightening - the reverse of quantitative easing - by selling its government bond holdings back into the market. The bank has also committed to offload all 20 billion pounds ($25 billion) of its sterling corporate bonds by the end of next year.

So instead of being the largest buyer in the room, the central bank will begin competing with the Treasury’s debt auctions. It has already stopped reinvesting maturing holdings, allowing a 28 billion-pound redemption in early March to run off its balance sheet. On Tuesday, the Debt Management Office increased its planned gilt sales for 2022-2023 by 5% to 132 billion pounds, still a substantially lower number than the market had envisaged even a month ago, leaving theoretical headroom for BOE sales to replace previously expected Treasury issuance.

Bank of America Corp. analysts expect QT to commence this summer at 5 billion pounds of gilts per month, rising to 9 billion pounds by November. Such a pace, if combined with additional interest rate increases, would be the fastest and largest stimulus reduction on record. At last week’s IMF conference, Bailey said the bank would pause active sales during “fragile markets” but he emphasized it was important to at least start the process. “You can’t have the constant ratcheting up of central bank balance sheets,” he said.

Unwinding monetary stimulus by selling its bond portfolio would be a subtler way for the BOE to calm inflation than relying on the blunt instrument of raising borrowing costs. It will need to be mindful of maintaining financial stability: A credit crunch triggered by a too rapid contraction is the last thing the U.K. needs. But it’s time policy makers reached deeper into the tool box to combat rising prices without driving the economy into recession.

More From Bloomberg Opinion:

• The Fed Is Losing ControlOver the Inflation Narrative: Lisa Abramowicz

• U.K. House Prices, Meet the Cost-of-Living Crisis: Stuart Trow

• The ECB Must Act to Avoid a Currency Crisis: Marcus Ashworth

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Marcus Ashworth at mashworth4@bloomberg.net

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Mark Gilbert at magilbert@bloomberg.net

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