The Bank of England is monetising government debt and has implicitly admitted a policy error

7th December 2011 by Shaun Richards

After looking at the Euro zone for a couple of days I would today like to take a look at the UK economy. As an introduction I would like readers to think about something that took place yesterday. The UK Debt Management Office auctioned  some £2.27 billion of 4 1/4% Treasury 2040 which is a UK government bond or gilt. Not such a surprise you might think as with the UK fiscal deficit we need to sell plenty of debt and in particular if we look at this gilt we also maintain a high average length of our natioanl debts maturity. The interesting counterpoint is that the Bank of England purchased some £1.7 billion of UK gilts which mature in the period 2038 to 2060 as part of its Quantitative Easing operation!

Is this debt monetisation?

In effect yes and is about as near as we are likely to get. The Bank of England is not allowed to buy what is called a primary issue (which means something we are selling/issuing at that point in time). However it can operate in similar stock and as yesterday it bought £445 million of 4 1/4% Treasury 2039 you can say that it bought something as near as possible! One year apart in 29 years does not make much difference and as it bought some £509 million of 4.5% of Treasury 2042 you can see that it was surrounding the target area. So yes this was in my opinion debt monetisation by the back door so to speak.

The amount purchased was lower than the amount issued but it is also true that the Bnak of England also purchased much longer dated gilts out to our longest which matures in 2060. So if we allow for what is called duration then the effect of the purchases if we compared it to buying a 2042 bond would be higher than the £1.7 billion actually spent.

Whilst only £7 million was spent yesterday on our longest dated gilt regular readers will be aware that I have long argued that a weakness of QE is a lack of an exit strategy from its proponents. If we take the one suggested by David Blanchflower of letting the gilts mature than QE would be with us until 2060 which is not much of an exit!

The Bank of England announces a new emergency measure

If we keep the fact that central banks were planning exit measures from their range of extraordinary moneatry actions then you are in the right frame of mind to review what is in effect yet another policy reversal from the Bank of England. Here is the announcement from yesterday.

In light of the continuing exceptional stresses in financial markets, the Bank of England is today announcing the introduction of a new contingency liquidity facility, the Extended Collateral Term Repo (ECTR) Facility. This Facility is designed to mitigate risks to financial stability arising from a market-wide shortage of short-term sterling liquidity.

Sorry about the name which is a bit of a mouthful and seems like one part of the UK at least is mimicking the Euro zone’s behaviour! One lesson is clear and that is that the Bank of England is worried as central banks rarely use such language as “exceptional stresses”. Mostly this is because their job is to deal with them and so there is an element of an admission of defeat here in having to make a public announcement. It is easy to forget in these days when central banks parade their actions but they used to operate in the shadows so to speak. If we look back we see that the operations “in the shadows” were much more successful in general than the current publicised operations.

So whilst the Bank of England tries to engage in some message spinning by adding this to the statement.

There is currently no shortage of short-term sterling liquidity in the market.

Now this is either untrue already or they are worried there is about to be a shortage otherwise why are they doing this? You could consider this as part of the UK’s concerns about the rising credit crunch in the Euro zone ( the one which is invariably officially denied….).

The Special Liquidity Scheme

This is something that the Bank of England has not only been winding down but has in fact accelerated its withdrawal from its peak of £185 billion. It purpose may seem rather familiar.

to improve the liquidity position of the banking system by allowing banks and building societies

Now whilst it was operating over a longer time period that the EHCTR is expectd to currently I do not think that anybody will be suprised if the term of the EHCTR ends up being extended. In fact we have seen recently in the Euro zone that the European Central Bank has ended up doing exactly that with its extraordinary monetary measures.

This is a subject I have a track record on as the first article I wrote for Mindful Money just under a year ago (December 14th 2010) stated that I thought that the accelerated withdrawal of the SLS was a policy error. Here was my conclusion for then.

Just as I was thinking it would be sensible to defer the end of the scheme and reduce it in stages the Bank of England has in fact accelerated its end. I wonder if any of them want a mortgage or plan to sell or buy a house in 2011?

Actually I feel vindicated as I took a fair bit of criticism for arguing this point (there always seem to be plenty of “experts” willing to argue in favour of the staus quo or official policy regardless of what it is or was…) but is anyone now willing to argue that bank liquidity has not been squeezed in 2011? It may seem obvious now but when UK bank share prices were higher in the spring of this year there were many arguing that there was no problem at all and that my view was wrong. Many of them were also arguing we would be able to sell our part-nationalised banks at a profit, how has that turned out?

A problem which the new scheme shares

The SLS gave out liquidity or cash if you like and received collateral in return. Unfortunately some of the collateral was what was called “phantom securities” and if you want an explanation just think of the name!  This hoodwinking of the Bank of England may be why it wnated to get rid of the SLS but as Karl Mark pointed out history has a way of repeating itself and the new plan has a wide collateral window. So will anybody be surprised if it ends up being filled with dross too? Particularly if one reads its notice and the emphasis is mine.

 the new Facility gives the Bank additional flexibility to offer sterling liquidity in an auction format against the widest range of collateral.

Let us remind ourselves of the Karl Marx quote one more time.

History repeats itself, first as tragedy, second as farce.


This is quite a reversal for the Bank of England as it is slowly reintroducing a programme that it should never have got rid of. In the meantime the UK economy has suffered from a lack of liquidity which the SLS would have helped with. If we put this into today’s figures for the real economy below we have food for thought.

The seasonally adjusted Index of Production fell by 1.7 per cent in October 2011 compared with October 2010.

We do not know how much of a difference improved bank liquidity would have made to the current state of the UK economy but I think everybody reading this would suspect that it would have helped.

Instead the Bank of England gave us an extra £75 billion of Quantitative Easing. A policy which has inflationary implications and ties us in at the extreme case to 2060 and further reinflates the UK government debt price bubble. If it helps bank liquidity it does so in return for taking UK government bonds off them which of course are very liquid anyway. so in a nutshell is my argument that the Bank of England has made yet another policy error as it has an inflexible very long-term operation (QE) replacing a more flexible one  (the SLS) and by the new measures introduction even it thinks that it is failing to help much. Ohterwise why is it doing it?

Here is a link to my original article

12 thoughts on “The Bank of England is monetising government debt and has implicitly admitted a policy error”

  1. JW says:

    QE is inflationary when it swops cash for bonds, but SLS or EHCTR swops of cash for ‘the widest range of collateral’ isnt?
    BoE did better when it operated ‘in the shadows’ , but we should elect the members of the monetary committee?
    The ECB’s balance sheet is full of rubbish, but the BoE should be encouraged to have loads of ‘the widest range of collateral’?
    Going back to the EZ for a moment. The ECB must be correct in saying that it is not LOLR for sovereigns. But if Markozy get their ‘treaty change’ for sovereign debt control, ECB follows that up with LOLR for european banks. The sovereign/banking death spiral is broken and S&P can remove its threat.

    1. Anonymous says:

      Hi JW

      Let me run through your points.

      I think that QE differs from direct liquidity provision is that is splashes around the economy rather than going to a specific place the banks, it is also inflexible when they can be withdrawn more quickly and I would use SLS/ECHR in response to a specific problem. Accordingly whilst one cannot rule out some inflationary pressure it should be much less.

      Sadly the days when central banks were “in the shadows” have gone for quite some time and accordingly my proposals are to help it back to a better place and to make improvements on where we are which unfortunately is very different from where one would want to be.

      The collateral problem is a big issue and I would look to deal with it by getting skilled staff to deal with it. I think the SLS had elements of a panic move initially and the banks spotting this picked the B of E off.

      As we stand in the Euro zone it is the national central banks who are lenders of last resort (LOLR) and this cannot go to the ECB in my opinion without a lot more fiscal union.

      1. JW says:

        Hi Shaun, thanks for the comments. I have some follow-up.
        Surely the vast majority of bonds that QE swops for cash is also with the Banks, and therefore has the same inflationary effect as SLS/ECHR?
        Isn’t a consolidation of LOLR in ECB from national central banks, a purely monetary issue? Yes it needs a parallel fiscal ‘union’ , but isn’t that exactly what Merkozy are planning?

        1. Russell Branch says:

          Planning is one thing, achieving it is entirely another:
          “Soon, ze whole ov Europe vill be mine, mine I say!”

  2. Anonymous says:

    Thanks for this blog. I do not pretend to understand what is going on but I feel that you do and that you are willing to explain things we do not get elsewhere in the media or online world.

    It seems to me after reading this that the Bank of England is not doing a good job but that the truth is usually hidden

    1. Anonymous says:

      Hi Josephine

      Welcome to my part of the blogosphere and thanks for the compliment.

  3. sensemakesnosenseeconomics says:

    hi shaun

    lifting the carpet as usual i see.

    it seems we have technocratic governmenance here in the uk ala b.o.e monetary policy commitee  .as you pointed out in previous posts they are unelected body without direct accountability to the populace .essentially taking crucial decisions with our future.
    maybe you can answer how many members are ex goldman sachs .how long before these sachsocrats or squidocrats have full control of the wests economies.

    1. Anonymous says:

      Hi Sense

      You make a good point about a technocratic Bank of England. As you know I have suggested it should be elected and have replied to the Financial Secretary to the Treasury’s letter I posted last week and will post any reply on here.

  4. ChrisLongs says:

    All these BoE statements released whilst the Euro circus reaches fever pitch may be as near as they get to the shadows for hiding their mistakes.
    I still consider energy prices will be the knock on problem not only for consumer prices next year but also for industrial production. Expect squeeze on margins to be next excuse for more job shedding as these have held up so far.
    Still MPC & OBR convinced RPI & CPI to fall quickly iin 2012 – where have we heard that before?

  5. Anonymous says:

    Hi Shaun
    Just rejoining the debate following a pause. What interests me about the Sterling Monetary Framework is who is valuing the collateral – gilts have already been loaned by BoE against narrow and wide collateral and this new liquidity is being auctioned against the same collateral-type at Adjusted Market Value. Who is signing off this valuation? BoE?

    1. Anonymous says:

      Hi Shire and welcome back

      I have taken a look at the documentation and cannot promise I am fully on top of it yet but in the document I have put a link to one sees this bit “The Bank may, in its absolute discretion, either generally or in particular circumstances, waive, add to or vary the above eligibility criteria” which makes me think that it will be the Bank of England.

  6. Drf says:

    “…so in a nutshell is my argument that the Bank of England has made yet
    another policy error as it has an inflexible very long-term
    operation (QE) replacing a more flexible one  (the SLS) and by the new
    measures introduction even it thinks that it is failing to help much.
    Ohterwise why is it doing it?”  It is doing it as the only way to balance the UK treasury’s current account! The UK is essentially insolvent because the government will not or does not have the competence to be able to cut public spending to what the UK can actually afford at present, but despite all the talk of cuts has allowed expenditure to continue rising and rising out of control.  The only way thus that this can now be funded as the economy flounders and tax revenues fall is by debasing Sterling, and that is the clear integral objective of all of these gambits. The combination of an artificially low contrived continued “emergency” base rate below present and ongoing inflation, the BoE “purchasing” large tranches of government debt with Monopoly money and QE in all its various forms is a desperate set of measures to try to appear to maintain solvency for as long as the deception can continue. King is just a puppet of the present government, as he was of the last. QE has presently many different and cummulative forms now being implemented continuously, and they are all additive algebraicly in their mal-effect on the UK economy in terms of debasement. It must be recognised that particularly in an advanced economy debasement destroys the real wealth generating processes.

    Forget any exit strategy. They do not have one nor do they intend one.  Just as since the WWII there was never any redemption (exit strategy) in the true Keynesian prescription, as they used debasement to pay-off and to service public debt, it is now even worse. The obscene objective now is to generate increasing inflation to pay off a significantly large amount of the public debt, and to fund a large portion of the present public debt-servicing costs. This is Zimbabwe economics and it will end in the same now well-understood fashion as the economy continues to decline.  All other diversions are a red herring to attempt to deceive. These people are the very worst confidence tricksters at the highest possible level!

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