The Great Debate

from The Great Debate UK:

Bank of England faces dilemma on QE extension

John Kemp

Apr 9, 2009 10:18 EDT

-- John Kemp is a Reuters columnist. The views expressed are his own --

LONDON, April 9 (Reuters) - The Bank of England's terse press statement announcing it will maintain overnight rates at 0.5 percent and continue the existing 75 billion pound quantitative easing (QE) programme gives no clue about whether the Bank intends to extend the programme when the first tranche of asset purchases are completed in June. But officials will have to make a decision soon: unless they signal a commitment to extend QE, gilt yields will rise even further in anticipation that the major buyer in the market will withdraw. The QE programme is dogged by ambiguity about its objectives (which a cynical observer might conclude is deliberate). Officially, the aim is to prevent inflation falling below target by accelerating money supply growth, not manipulate the yield curve for government and corporate debt. In this, the Bank's avowed strategy is more conventional than the Fed's ambitious efforts to determine the cost of credit for borrowers throughout the economy. It is a straightforward quantitative easing patterned on the Bank of Japan, rather than a credit easing patterned on the Fed. If true, the measure of success is how much the money supply has been boosted at the end of the three month period; the Bank should be indifferent about whether ending QE causes yields and borrowing costs to rise. So long as money supply has risen consistent with the inflation target, and the Bank can discern some green shoots of stabilisation if not recovery, officials can declare victory, end the programme, and keep the other 75 billion pounds of asset purchases authorised by the chancellor in reserve. Yields can be left to find their natural level. But many suspect the Bank's real objective is yield control -- in which case it will have to announce another round of buy backs of gilts and corporate bonds in good time, well before the current programme is completed, to shape market expectations. The results of the existing round have been unimpressive. After falling initially, gilt yields are almost back up to the level they were at before the Bank's foray into unconventional monetary policy. The snag is that if the Bank stops buying, other investors will struggle to absorb all the new government paper on offer without a major increase in yield -- pushing up borrowing costs for everyone, precisely what the Bank has sought to avoid. The Bank's dilemma is whether to push on (heightening fears about inflation) or call a halt (risking a spike in yields all the same). Either way, the Bank needs to give the market, as well as the Treasury and the Debt Management Office, plenty of warning about its intentions. (Editing by Richard Hubbard)

Playing chicken with the Fed

John Kemp

Feb 4, 2009 09:01 EST

– John Kemp is a Reuters columnist. The opinions expressed are his own –

Yields on long-term U.S. Treasury debt continued to surge higher yesterday as the market braced for a future upturn in inflation and a tidal wave of long-dated issues that will be needed to fund the bank rescues and the emerging stimulus package.

Yields on three-year notes are up by around 47 basis points from their mid-December low. But yields on ten-year paper have soared 82 points and rates on the 30-year long bond have surged 114 points. Long-bond rates have retraced more than half their decline since the autumn (https://customers.reuters.com/d/graphics/USTREAS.pdf).

Back-end yields would probably have risen even further were it not for persistent hints the Federal Reserve is thinking about buying longer-dated issues to cap them. But the market has started to call the Fed’s bluff.

MANIPULATING THE FRONT END

In the press statement accompanying its most recent interest rate decision, the Federal Open Market Committee (FOMC) gave a clear commitment it will keep short-term rates at “exceptionally low levels for some time.” In practice, the Fed will probably hold rates close to zero for the next two to three years until a cyclical recovery is well underway. But thereafter rates will need to rise to more normal levels to contain inflationary pressures.

The steepening yield curve reflects an assumption the Fed’s zero-interest rate policy will dominate the whole yield on debt maturing in 2009-2011, but have a diminishing effect on securities which mature further in the future.

Betting on the unthinkable in the euro zone

J Saft

Jan 16, 2009 09:05 EST

— James Saft is a Reuters columnist. The opinions expressed are his own –

Some crises bring partners closer together. Some, as investors in the euro zone are likely to discover this year, drive them further apart.

Look for rising tensions about fiscal and monetary policy among the bloc’s 16 member nations, and for a bigger penalty to be imposed on the euro and some euro zone assets against the possibility of a breakup or a secession from the currency group.

The liquidity crisis of last year left smaller members of the euro thanking their lucky stars they were inside a big warm tent with a major currency and critically, a powerful central bank that could help banks and maintain order in financial markets.

Ireland and Greece, to name but two, could look at the disaster in Iceland, which suffered a banking and currency collapse, and see the real tangible benefits of membership.

But now that the crisis has morphed into one in the real economy, with exports plunging and employment hit, things will be less cohesive within the euro zone, with one currency having to do duty for different countries with different economies and levels of competitiveness.

European governments vary widely in their ability to withstand the fiscal squeeze from falling tax receipts, as well as having varying ability to credibly take on programs of stimulative deficit spending. That of course is about all that euro countries have open to them when it comes to unilateral action, being forced as a condition of membership to live with a common currency and interest rate policy.