Bank of England won’t return balance sheet to pre-financial crisis levels, Bailey warns

The BOE is currently unwinding about £20 billion ($25 billion) of quantitative easing every three months, both as assets mature and as they are actively sold.

Bank of England, banking sector crisis, balance sheet, quantitative tightening, UK taxpayer, asset prices, inflation, unemployment, financial crisis
The pace at which the Bank of England shrinks its balance sheet is likely to accelerate. Image: Reuters

The pace at which the Bank of England shrinks its balance sheet is likely to accelerate, according to one of its deputy governors. The BOE is currently unwinding about £20 billion ($25 billion) of quantitative easing every three months, both as assets mature and as they are actively sold. Dave Ramsden, deputy governor for markets, told UK lawmakers Thursday: “There’s the potential for us to go up a little bit. I don’t see us going down given the experience of the first year.”

The BOE began unwinding its giant QE program in February last year, when bonds were allowed to run off as they matured without the funds being reinvested. In November, it began active sales. Fears that the process, known as quantitative tightening, would destabilize markets have so far proved unfounded. The QE portfolio grew to £895 billion in the pandemic but has has since shrunk to around £820 billion.

The target is to reduce the stock by about £80 billion a year, split roughly evenly between active sales and maturing assets. Ramsden said the BOE was likely to at least maintain the £40 billion annual rate of active sales, even with redemptions set to rise to around £50 billion. The Monetary Policy Committee had been advised by BOE markets officials at the outset of QT that anything above £100 billion “might disturb market liquidity,” Ben Broadbent, deputy governor for monetary policy, told the MPs.

QE Losses

The QE program is incurring losses as it is being run down and the BOE is under pressure from the Treasury to deliver “value for money” as the assets are redeemed or sold. The BOE currently projects the program to cost the UK taxpayer about £100 billion over its lifetime. Ramsden, a former Treasury official who negotiated the government indemnity with the BOE when QE began in 2009, said he was “very conscious of these value for money issues.”

“The Treasury accounting officer needs to be confident that the way the auctions are being conducted is providing that value for money.” BOE officials including Governor Andrew Bailey were at times forced on the defensive in a combative exchange in which MPs accused ratesetters of failing to anticipate inflation, of being inconsistent in their judgments and of driving up prices and inequality with QE.

Broadbent countered that had they stopped QE earlier, it would have only reduced inflation by about a quarter point from its current level of 10.1% – five times the 2% target. He also insisted that QE merely accentuated existing levels of inequality by increasing asset prices, rather widening the gulf between the rich and the poor in relative terms. 

No Return

“I don’t recognize the commentary about asset prices and inequality and how QE worked on this,” Broadbent said. Standard inequality measures, such as the Gini coefficient, have been “completely flat” for about 30 years, he said. QE helped protect incomes among the poor by reducing unemployment, he added. At the same hearing, Bailey told the Treasury Committee that the BOE will not return its balance sheet to levels seen before the 2008 financial crisis. He said the BOE wants to reduce the balance sheet to give it headroom to respond to events in the future, but indicated that it will remain in the hundreds of billions of pounds. 

Before the financial crisis the balance sheet was less than £100 billion. “I do not envisage the balance sheet returning to what it was before the financial crisis,” Bailey told MPs. “The reason is the stock of reserves, the deposits banks make with us. That’s the highest form of bank liquidity. There is no question that the need for banks to hold larger cash reserves from a financial stability point of view is important.”

“My view on this is that it’s important from the point of looking forwards that the bank balance sheets adjusts so that it has headroom to do whatever we might need to do in the future.” Ramsden said he expected the impact on markets of QT “will be small.” Bailey stressed that QT was “not the active monetary tool” for tackling inflation, which is interest rates.

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First published on: 19-05-2023 at 10:40 IST