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