Bank of England likely to undertake quantitative tightening

The Deputy Governor for monetary policy at the Bank of England has suggested that the bank will most likely start to sell the £895bn of assets it has purchased under its 13 year history of quantitative easing (QE).

Ben Broadbent mentioned, whilst speaking at a Bank of England Agenda for Research (BEAR) conference, that the bank could continue to sell assets regardless of changes (both cuts and raises) in the bank rate.

QE works by injecting huge amounts of liquidity into the economy which should work to encourage lending and borrowing to spend. The central bank purchases assets issued by firms and the Government which lowers the yield on these bonds. Looking for a better return, investors in the economy look to purchase other assets, which lowers the yields on these other bonds. Yields are now low across the economy which allows interest rates on savings and loans to be cut further, incentivising increased spending and investment funded by credit.

QE is reversed in a process sometimes known as quantitative tightening, which involves the central bank slowing down asset purchases and potentially selling off assets.

The Bank of England first introduced QE in the aftermath of the 2008 financial crisis in an attempt to stimulate spending and investment in the economy to allay fears over the condition of the UK economy.

More recently, the central bank undertook a huge asset purchase programme in response to the Covid-19 crisis to help prop up the economy during a time of great uncertainty.

However, fears that the programme was fuelling high demand-pull inflation have prompted the BofE to take a more hawkish turn. In February, the Bank started to wind down QE by stopping the reinvestment of returns on matured bonds. This, combined with intentions to sell the £20bn worth of corporate bonds purchased during the pandemic, will cause the amount of debt the Bank owns to fall by around £27.9bn this year.

The tightening programme is being rolled out gradually to prevent a sudden fall in the liquidity of financial institutions, which could potentially undermine the UK’s financial stability. A sudden rollout could trigger a ‘’taper tantrum’’ as seen in the US in 2013 when, the then chair of the Federal Reserve, Bernanke announced the Fed’s intentions to scale back asset purchases - markets were troubled and investors responded by selling their assets - bond yields rocketed and stock prices dropped - subverting both the credibility of the Fed and economic stability.

The tightening programme aligns with other contractionary monetary policy measures implemented by the bank, including the recent rise in interest rates to 0.5%.

These decisions are being taken to diminish inflation, which currently stands at 5.5% in the UK, well above target with CPI inflation estimated to reach 7.25% in April.

However, with the main causes of rising inflation being cost-push, raising rates and reducing QE may prove to be futile in preventing the impending cost of living crisis.


Written by Deandra Peiris Research compiled by Hubert Kucharski


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