Bank of England should put rate rises on hold and pause QT
- Bank of England must not raise rates again and should pause QT as tightening has gone too far and wider impacts need to be assessed.
- Monetary policy operates with lags and there is clear risk of overkill as the massive rate rises in recent months will take time to feed through.
- QE central bank bond-buying has undermined capital market risk models leaving pension funds and taxpayers exposed to large losses from QT.
Bank of England rate rises have gone too far – time for at least a pause: For the past few months, central banks have been pushing up short-term interest rates sharply, after belatedly recognising the post-pandemic inflation surge was not just temporary. The Government’s emergency cost-of-living support measures, high employment, easy access to borrowing and rising wages have cushioned the short-term impacts of higher rates on aggregate demand and many borrowers were on fixed rates that have yet to expire, but tightening will undoubtedly create weakness. As the full impacts of higher short-rates have not yet fed through the system and even traditional models suggest time lags in monetary policy of well over a year.
Monetary policy time lags will keep feeding through and there is danger of overkill as rates are already pushed up so sharply: The sharp rises in short-rates, coupled with Government commitments to restraining fiscal deficits, are bound to depress growth more in coming months. Indeed weaker jobs growth, rising corporate failure, weak monetary aggregates and lower confidence indicators are all signs of economic strain. It is quite possible that the Bank of England has already tightened more than it needed to, partly to placate market participants who lost confidence in our economic management last year. Further tightening would, in my view, risk compounding the situation – especially amid rising global tensions – to the detriment of future stability.
Pension schemes have also been hit as short-rate rises were accompanied by higher long-term rates further adding to monetary tightening: The impact of higher short-term rates may not yet have fully fed through to the economy, but long-term interest rates have soared at the same time, compounding risks of weakness and particularly impacting many pension funds. Central banks ‘money-tree’ policies since 2009, which created £875bn new money under the fancy name of ‘Quantitative Easing’, drove interest rates down for many years, allowing Governments to borrow cheaply, boosting financial assets, pushing up property prices and enriching the wealthiest groups. The policy has distorted capital markets. QE was only meant to be a temporary experiment to help avoid deflation, but it benefitted so many powerful groups that it continued far too long. Once inflation took off, central banks suddenly reassessed QE and the Bank of England announced it would sell the bonds it had purchased. This was accompanied by significant bond yield rises (which mean investors holding bonds lost huge sums) and the bond rout caused severe losses for Defined Contribution pension investors. It also reduced the value of all pension funds, as Defined Benefit scheme assets fell by £500bn – £600bn last year.
Central bank bond-buying has undermined pension investors’ belief that gilts and bonds were stable, low-risk and less volatile than all other assets: Defined Contribution pension schemes using ‘lifestyle’ or ‘target date’ default funds, switch their investors out of higher expected return assets such as equities and put more of their money into gilts and other bonds as they reach their late 50s and early 60s. This was assumed to protect their capital, as pre-QE investment risk assumptions based on capital asset pricing models, considered government bonds as lowest risk or ‘no risk’ assets. Unfortunately, QE central bank gilt purchases artificially distorted bond markets by buying gilts regardless of yield and deliberately increasing their price. This added risk which capital market models did not adequately price in. Historic correlations on which investor risk models were predicated, were interfered with by central banks. People coming up to retirement lost significant amounts, suddenly finding they have 20% or 30% less in their pension fund than a year ago, despite being assured their money was being protected for them. Such people could be permanently poorer. This is a further argument for pausing central bank bond sales, to allow time for a careful assessment of QT impacts.
Taxpayers also face large losses as QT proceeds: The Treasury has fully underwritten the Bank of England Asset Purchase Facility for all losses on sales of the gilts they bought during QE operations. Last year, the Bank of England sold at least £80billion into the markets, and the size of its QE holdings shrank from the £895billion peak to £135billion by September 2023. It has also recently announced it plans to offload another £100billion in the coming year, with this overhang likely to keep depressing gilt prices. Given the distinct possibility that policy has already been tightened too far, it would be wise to put both rate rises and QT on hold for now, to assess the impacts more carefully. Defined Contribution pension schemes could shrink further and estimates already suggest taxpayers will lose £150billion when selling the central bank bond holdings. If inflation and interest rates settle down below current expectations, but only after DC members have withdrawn funds or DB schemes have sold assets, such losses will not be readily recovered.
Bank of England should stop pushing interest rates higher to allow time to assess the full impacts of its policies: Given the dangers of tightening too much and the risks to pension funds in an aging population, it seems prudent for the Bank of England to halt its monetary tightening. Inflation is already falling, there are signs of weakness in UK financial markets and fiscal policy is constrained by rising debt and interest costs. It was always inevitable that QE would cause some kind of crash when it ended, and I urge the central bank to more carefully consider the need to provide some stability in the current environment. It is necessary to properly assess how exceptional central bank policies have impacted the capitalist system itself and how to assess investment risk in these extraordinary times.