Mark Carney risks leaving his successor a 375 billion-pound ($630 billion) conundrum: what to do with the government bonds the Bank of England amassed during its stimulus plan.
BOE officials say unwinding quantitative easing is unlikely to begin until the key interest rate has risen materially from its record-low 0.5 percent because they want the option of cutting borrowing costs again if the recovery falters. Derivatives contracts suggest that point may not be reached before Carney leaves in 2018.
“They are well advised to leave it on the back-burner for the foreseeable future,” said John Wraith, a fixed-income strategist at Bank of America Corp. in London. “The impact of actively selling gilts is unknowable. Assuming Carney sticks to his intention to leave after one term, it’s highly likely that decision won’t happen while he’s governor.”
The asset purchases that began in 2009 to kick start the economy have left the BOE holding more than a quarter of the value of gilts outstanding. Its commitment to maintain the program has helped gilts return about 4 percent this year and reduced the 10-year yield to below 2.6 percent from 3 percent.
“To be able to use bank rate as an active tool in response to adverse shocks to activity, the MPC is likely to defer sales of assets at least until bank rate has reached a level from which it could be cut materially, were more stimulus to be required,” the Monetary Policy Committee said in its quarterly Inflation report this month. The report assumed the stock of purchased assets will remain unchanged for three years.
Carney, who took over the BOE from Mervyn King in July 2013, has said he plans to serve one five-year term.
Investors are betting the benchmark rate, which has been at an all-time low for more than five years, will rise 25 basis points by next May, according to Sonia contracts. They show the rate reaching 1 percent three months later and 2 percent in early 2017.
The implied yield on short-sterling contracts expiring in June 2018, which allow investors to bet on the interbank lending rate, is at 2.84 percent.
The BOE needs to start increasing its benchmark “sooner” rather than later if it wants to keep the pace gradual, MPC member Martin Weale said in an interview with the Financial Times published today.
“We can wait a bit longer. How long that ‘bit longer’ will be, I’m not sure,” Weale said. It’s “not so urgent it needs doing now,” he said.
The BOE’s dilemma about how to exit emergency stimulus echoes the debate at the Federal Reserve, with New York Fed President William Dudley saying the U.S. central bank should keep reinvesting money from expiring assets until after it raises interest rates in order to provide more flexibility over borrowing costs.
U.K. policy makers will also be mindful of clashing with the Debt Management Office, which has to auction about 100 billion pounds of gilts a year for the next few years, according to Bank of America’s Wraith.
Officials could reduce the stock of assets without active gilt sales if they decide to refrain from reinvesting the money from maturing bonds. Government bonds with a face value of about 23.9 billion pounds are set to be redeemed from the BOE in 2015, followed by 19 billion pounds in each of the following two years, according to BOE data.
“It will probably take at least 2 1/2 years before they start reducing their assets, and we are more likely looking beyond that,” said Richard Kelly, a senior fixed-income strategist at Toronto-Dominion Bank in London. “It may take them a while to go back to a more normal policy, which could very well coincide with the end of Carney’s tenure.”