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BOE governor signals dramatic shift towards stimulus

He stresses need to reduce institution's balance sheet - now almost £700b - before hiking interest rates

London

BANK of England Governor Andrew Bailey signalled a major shift in the central bank's strategy for removing emergency stimulus, stressing the need to reduce the institution's balance sheet before hiking interest rates.

Writing for Bloomberg Opinion, Dr Bailey said such a plan would give officials more firepower in future crises. The BOE's balance sheet has swelled to almost £700 billion (S$1.2 billion) because of its extraordinary measures during the coronavirus pandemic, and is set to grow much larger because of the central bank's bond-buying programme.

While the governor didn't say whether he favours paring back that programme or its lending facilities first, asset purchases make up the bulk of the BOE's balance sheet.

Before the coronavirus pandemic, Dr Bailey's predecessor Mark Carney said the central bank would wait until rates hit 1.5 per cent before reducing its stock of assets.

"Elevated balance sheets could limit the room for manoeuvre in future emergencies," Dr Bailey wrote. "When the time comes to withdraw monetary stimulus, in my opinion it may be better to consider adjusting the level of reserves first without waiting to raise interest rates on a sustained basis."

The pound briefly pared earlier gains on the comments, and traded at US$1.2379 at 7.11 am London time.

That message is a warning shot to the multi-trillion dollar money market industry, which should be a key source of liquidity but which started to dry up when the crisis hit, forcing the BOE to step in.

The central bank has already criticised the apparent vulnerability of such funds, which faced difficulty selling assets to meet redemptions despite supposedly investing in short-term, low-risk securities.

"Rather than having to keep relying on central bank support for all aspects of the financial system, we need a robust assessment of the latter's weaknesses," he said. "The role of money market funds, and the risks to financial markets that they posed at the height of the disorder, is one area to examine."

Since Dr Bailey became governor in March, the central bank has cut rates to 0.1 per cent and announced plans to increase its asset-purchase target by £300 billion to contain the economic impact of the pandemic. It has also loaned money on generous terms to keep liquidity high.

The bond-buying will lead to an increase in the total stock of assets of at least 66 per cent in 2020, an expansion Dr Bailey says "mustn't become a permanent feature".

The governor didn't mention negative interest rates or yield curve control. He has previously said all policy tools are still on the table and that the bank would review the impact of sub-zero borrowing costs.

The BOE may have to ease even further before it can consider reining in stimulus. The UK will face the greatest economic hit from the pandemic of all developed countries this year, according to the OECD.

Both the European Central Bank and the US Federal Reserve have massively boosted their asset-buying again this year, along with extensive lending programmes.

The BOE last week increased its bond-buying plan by £100 billion, bringing its total target to £745 billion, the equivalent of almost 40 per cent of UK gross domestic product.

A previous expansion in March has been widely credited with calming a period of intense market stress in the early days of the pandemic, and keeping a lid on bond yields as the government stepped up borrowing to fund a massive expansion in spending.

Dr Bailey said the action "helped counteract the economic and market turmoil," and rejected claims the buying - which almost exactly matched the government's extra debt sales - compromised the BOE's independence.

"The fact that the predominant borrowers in this emergency are governments, reflecting the essential role of the state in such a crisis, makes no difference to the underlying economics or the importance of keeping borrowing costs consistent with central-bank objectives," he said. The BOE's "capacity to act must be reinforced and not mistakenly called into question". BLOOMBERG

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