-BOE Gilt Auction Maturities Key In How QE Drives Down Yields

LONDON (MNI) – The fears of Bank of England Monetary Policy
Committee members, that elevated inflation would result in households,
companies and financial markets expecting inflation to remain above the
2% target, have not been realised, according to a BOE research paper.

If anything, near-term inflation expectation risks have diminished
and there is little evidence of past inflation expectations feeding
through into wages. The paper, which appears in the BOE’s Quarterly
Bulletin, suggests that despite inflation running above its 2% target
for much of the past four years, inflation expectations are running
close to data series’ long run averages.

The paper, by BOE economist Rashmi Harimohan, says as long as
inflation is above target some risk remains from inflation expectations,
but the growing concerns of MPC members as inflation rose between 2010
and 2011 appear groundless.

The public and markets do not believe the MPC will eventually fail
to return inflation to target and, with headline inflation declining,
near-term expectations have eased.

“It seems that the upside risk from longer-term inflation – a
belief that the MPC is less able, or willing, to return inflation to
target in the longer term – has not crystallised,” the paper says.

“The near-term element of the upside risk – a belief that the MPC
has become more tolerant of deviations of inflation from target –
appears, if anything, to have receded a little,” the paper says.

The risk of inflation expectations becoming de-anchored has been
one argument against the MPC providing further stimulus. Another is that
further quantitative easing could have little effect.

Another paper in the Quarterly Bulletin looks at a key channel
through which QE continues to influence gilt yields – the “local supply”
channel.

The paper highlights evidence that the maturity ranges the BOE
selects to purchase gilts through its reverse auctions are key to QE’s
impact on yields.

Pension funds, for example, prefer to hold on to long dated gilts
for asset/liability matching purposes, and so there is an in-built
preference for gilts at specific maturities.

“If some investors do not view gilts of different maturities as
perfect substitutes … then central bank purchases expected in a
specific maturity range can reduce the remaining supply of gilts
expected to be available … lowering yields in that part of the yield
curve,” the paper says.

This local supply channel “can account for around half of the
reduction in gilt yields due to QE,” the paper says.

The article says the effectiveness of QE through this channel has
not diminished. Experimental results “suggest that the strength of this
channel has not changed since 2009.”

The paper, however, notes that lowering gilt yields is only the
first step in QE’s transmission through to spending and inflation, and
the paper does not look at the wider economic effects of QE.

–London bureau: 44 20 7862 7491; email: drobinson@marketnews.com

[TOPICS: M$$BE$]