MPC reaction: A plan for quantitative easing

Today’s MPC announcement addressed policy decisions on two aspects of monetary policy. First, the level of the Bank rate; and second, the planned reduction in the number of gilts held for monetary policy purposes, the amount of Quantitative Tightening (QT), from October onwards. 

On the first, the committee voted to maintain the level of the Bank rate at 3.75%, as widely expected, including by ourselves. As at the previous meeting in July, the vote was 6-3 with Megan Greene, Catherine Mann and Huw Pill backing a 25bp increase. The majority group argued that domestically generated inflation had continued to fall, that there were few signs of secondary inflation pressures showing through as a result of higher energy costs and that pay growth, for now, remained constrained by soft labour market conditions.  

But energy prices had continued to climb in response to the geopolitical situation and the committee acknowledged that the risks of a medium-term overshoot of the 2.0% inflation target had risen since the previous meeting in July. Moreover, although higher longer-term rates had led to a tightening in financial conditions, for example via more expensive mortgage rates, waiting for too long to raise borrowing costs was not appropriate, bearing in mind the lags before evidence of second-round effects could be expected. It was pointed out that the uncertainty surrounding events in the Gulf could mean that the inflation outlook could shift materially (i.e. improve) very quickly. Nonetheless Andrew Bailey, Sarah Breeden, Clare Lombardelli and Dave Ramsden all warned that the case for a rise in the Bank rate was building and that there was an argument for tightening policy if the conflict were to last much longer.

In short, the MPC’s collective monetary policy position is one of an ‘active hold’, where a combination of pre-Iran war disinflation and a tightening in financial conditions offsets the impact of higher energy prices in the medium-term. But this is now a precarious balance which would be upset by a further climb in energy costs or an absence of clear signs of an easing in the conflict. Without a positive U-turn in the Iranian conflict and with it a resounding decline in oil and gas prices, the risks of a 25bp rise in interest rates in November are looming large. 

The second MPC decision concerned QT. This was more technical than in previous years. Our expectation was that the Bank would opt for a pace of balance sheet reduction of around £50bn in the year from October, allowing some £30bn of expiring bonds to run off the Asset Purchase Facility (APF) and £20bn or so of active sales of gilts. Instead of taking a decision simply for the upcoming 12 months though, as before, the committee opted to take a longer-term, multi-year approach, taking the view that it will sell or let expire £368bn of the £488bn of gilts in the APF by September 2034, with the remaining £120bn left in place to back the stock of banknotes. The Bank envisages keeping hold of its longest-dated gilts. This would entail keeping all bonds with a maturity beyond the 1.75% 2049 gilt. On that gilt specifically, the BoE plans to keep £7.8bn of its holdings, while £15.0bn will be sold. This would take the number of gilts held for monetary purposes down to zero. The average annual reduction in the APF would be £46bn, with active sales comprising £20bn of this. 

In addition, where active sales do take place, it is proposed these will made to the government via the Debt Management Office (DMO) rather than to markets via auctions. The DMO would fund its purchasing by adjusting its financing remit each year to take this into account. In other words, the DMO rather than the Bank of England would be auctioning all debt to the market. The BoE will review progress on operationalising this plan before making a final decision by April 2027 on whether or not to proceed. In the meantime, active sales of gilts will be postponed. 

To our minds the plan to use the DMO as an intermediary makes operational sense. Reducing the number of official sellers seems logical, not least because this helps to reduce what potentially becomes a crowded calendar of gilt auctions.