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Bank of England gradually embarks Quantitative Tightening

The Bank of England is set to sell its government bonds purchased over past decades of quantitative easing. This is primarily during the COVID-19 pandemic, which has fueled the high rate of inflation witnessed in the country today. Sales of its government bonds acquired over the years worth more than 40 billion pounds (equal to $49 billion) with the hope of reducing the amount of money in circulation.

The sales of these bonds will officially commence in the second half of September. Still, they will be subject to changing market and economic conditions. It would require a final confirmatory vote during its meeting on 15th September 2022.

Dave Ramsden reported that there would be a need for a constant amending adjustment of the gilt sales due to the changing market conditions once the program begins next month.

However, he further explained that the BoE does not expect the gilt sales to play a significant role in tightening the monetary conditions relative to raising interest rates. Here, the bank only hopes to confirm that it has enough scope to undertake QE whenever the need arises.

However, analysts believe that the sales do not bear much impact on gilt yields, especially when properly communicated. The only risk associated with this, as many supposed, was the risk of high volatility due to an apparent lack of short-dated gilts in Britain's repurchase market.

The BoE would set up a new weekly 7-day short-term repurchase facility which will assist the committee in keeping the market rates close to its bank rate.

The primary cause of the increase in the number of bonds purchased earlier by the government resulted from the COVID-19 stimulus package, where the government doubled its purchases in 2019, targeted toward boosting the economy during the lockdown. However, they failed to reinvest the proceeds of the maturing gilts, which led to its portfolio shrinking to 844 billion pounds from 875 billion pounds of bonds acquired.

Andrew Bailey stresses that the bank should first reduce its gilt holdings by 50-100 billion pounds during the first year of quantitative tightening. They should then maintain the same tempo in the succeeding year.

Thus, the BoE would be expected to cut its holdings by 80 billion pounds from September and maintain the tempo until the gilts mature. Here the bank hopes to achieve over 10 billion pounds in bond sales per quarter.

The sales, no doubt, will be time to avoid clashes with the United Kingdom Debt Management Offices gilt auctions.

What is Quantitative Tightening?

Quantitative tightening is an essential monetary policy employed by the Central Bank to reduce the amount of money in circulation. Through this process, the Central banks sell off all the government-accumulated bonds to normalise their balance sheet. Quantitative tightening is a good tool for fighting inflation as it creates more value for the country's currency by reducing the amount of money in circulation.

Quantitative tightening is a contractionary monetary policy employed by the Central Bank to reduce the amount of money in circulation, reduce liquidity and trigger more demand for the currency. This will lead to more productive engagements within the country.

What are the primary goals of Quantitative Tightening?

The primary goals of Quantitative Tightening have been summarised below:

  • Reducing the amount of money in circulation (deflationary) within the country
  • Creating more demand for the currency
  • Increases the productive activities in the quest to make money
  • Increases the costs of borrowing and the benchmark interest rate
  • Reduces the rate of inflation without destabilising the economy

What impact will Quantitative Tightening have on the pounds?

Quantitative tightening is one of the tools employed by the Central Banks in fighting inflation. A significant advantage of this policy is that it creates more demand for the currency when the supply is reduced. The principles of demand and supply are known to go together. Hence, the significant advantage of embarking on Quantitative Tightening is increasing the currency's order and reducing inflation.

Consequently, it is expected that more pound demand will arise from next month when the bank is expected to commence this policy.

What are the risks associated with Quantitative Tightening?

Even though Quantitative Tightening has many advantages, some disadvantages are associated with it. We have therefore outlined them below:

  1. Massive reduction in bond prices: The sell-off of long accumulated government bonds by the Central Bank increases the liquidity in the bond prices, lowering the bond price.
  2. Reduction in Stock Purchases: A reduction in the amount of money in circulation affects the equity market, especially stocks. Investors find it challenging to obtain easy money to invest in the stock markets. This can trigger a crisis in the performance of stocks.
  3. Slowed economic growth: Reduced circulating money can slow economic growth as companies now find it difficult to obtain money to continue their productions.
  4. Increase in unemployment rate: A significant disadvantage of quantitative tightening is that it could increase unemployment as companies now find it challenging to increase their productivity. This results in companies reducing their expenses and laying off some workers.
Last Updated: 08/08/2022

This market commentary and analysis has been prepared for ATFX by a third party for general information purposes only. Any view expressed does not constitute a personal recommendation or solicitation to buy or sell as it does not take into account your personal circumstances or objectives, and should therefore not be interpreted as financial, investment or other advice, or relied upon as such. You should therefore seek independent advice before making any investment decisions. This information has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. We aim to establish and maintain and operate effective organisational and administrative arrangements with a view to taking all reasonable steps to prevent conflicts of interest from constituting or giving rise to a material risk of damage to the interests of our clients. The market data is derived from independent sources believed to be reliable, however we make no representation or warranty of its accuracy or completeness, and accept no responsibility for any consequence of its use by recipients. Reproduction of this information, in whole or in part, is not permitted.


 

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