Three Big Questions on the BoE’s Operations

The Bank of England (BoE) has intervened to stabilize specific parts of the gilt market in recent weeks. With its gilt purchases slated to end on 14 October, Senior Sovereign Analyst Jon Levy tackles three big questions on the BoE’s operations.

1. Were the BoE’s actions just about addressing market dysfunction, or more?

In my view, the BoE focused on addressing market dysfunction. However, the BoE was aware that pension schemes were forced sellers in the particular segments of the gilt market in which the bank has now operated. The BoE was careful to avoid suggesting that its actions are more broadly aimed at pension schemes.

2. What are the takeaways from this episode?

The BoE’s gilt purchases are not quantitative easing in my view because there is no “E”; the intervention is not intended to ease monetary conditions. In fact, monetary conditions now need to be even tighter due to the government’s fiscal measures. My view is that the market volatility arose, at least in part, because gilt yields did not adequately incorporate information about monetary and fiscal dynamics. The market failed to appropriately price interest rate risk, and I think this is still a problem. I would note that there appears to be an implicit warning in the BoE’s actions and communications: fix the problems that caused this market dysfunction, because we do not wish to intervene again.

More specifically, when it comes to pension fund considerations, I’ll continue to keep an eye on the government’s policy agenda. The “growth plan” Chancellor Kwarteng released in September hints at efforts to bring about shifts in pension fund asset allocations, and the stresses of the past few weeks may be incorporated as an argument for this effort.

3. In a high-inflation environment, do the old central bank playbooks still apply?

Market interventions and financial stability actions in an environment of high inflation are often significantly different than those in an environment of low inflation and deflation risk (to which the market has been accustomed for more than a decade). I believe the implicit warning in the BoE’s recent actions and communications speaks to this difference. The BoE is an inflation-targeting central bank, and it has been emphatic about the primacy of its mandate.

Somewhat ironically in my view, the BoE has addressed concerns about price distortions and related stability issues arising from QE more proactively than most major central banks. It has also stressed the importance of ending accommodation when it believes economic conditions no longer warrant it. With the volatility of the past weeks, the BoE has had to delay the long-planned sales of the gilt portfolio it built up when it was buying gilts for the purposes of easing. It does not appear to want to delay this any longer. Indeed, the BoE under Governor Andrew Bailey has made this argument in part to preserve the impact of interventions such as those it has now been conducting.

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