Bank of England Asked Some Uncomfortable Questions About Longevity of Quantitative Easing Programme

Pound Sterling has been the best performing currency in the G10 family so far this week with a good deal of the performance being owed to the dynamics involved in this week's quantitative easing programme.

• Quantitative easing could become increasingly difficult to deliver, particularly on long-dated Gilts
• Sir Martin Sorrell: UK 'perking up'
• PIMCO's Amey sees limited impact to economy from Brexit vote

The Pound has strengthened as positive data-flow has seen markets cut back on their expectations for another Bank of England interest rate cut in 2016 - the chance of a 0.15% cut is now down to 50%.

As these odds decrease, expect the Pound to rise as it is the cutting of interest rates and boosting of quantitative easing that has undermined the Pound of late.

The big achilles heel for Sterling at present, though, is the quantitative easing programme - the injection of vast quantities of money printed at the Bank into the economy.

This pushes Sterling lower as it 1) decreases the unit value of the currency though increased supply and 2) drives down yields, which in turn reduces foreign investor inflows into the UK, therefore lowering demand for our currency.

Latest Pound/Euro Exchange Rates

	Live: 1.146▲ + 0.15% 12 Month Best: 1.2162
*Your Bank's Retail Rate	1.107 - 1.1116
**Independent Specialist	1.13 - 1.1345 Find out why this is a better rate

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

Quantitative Easing: Can this 'Pound Killer' go the Distance?

A boost for Sterling came on Tuesday the 23rd of August when the results of the BoE’s latest quantitative easing reverse-auction were made public.

The results showed the Bank did indeed achieve their target of buying back £1.17BN worth of bonds with a maturity in excess of 15 years.

However, the target was met with a cover ratio of just 1.54.

The cover ratio is simply the ratio by which the offers exceeded the purchase request and it acts as a good signal as to just how effective the broader QE programme is performing.

The first reverse-auction for bonds with a maturity in excess of 15 years caught the market’s attention in the first week of BoE buying, with a cover ratio of just 0.96, which meant the Bank failed to execute its programme.

The Pound rallied on the result of this failure as markets wondered if the Bank would ever be able to fulfil its plan on purchasing up to £60BN worth of UK government debt.

The auction the following week was more successful with a higher cover of 2.67, and the Pound traded lower.

The most recent result does however show the the cover ratio may be falling again; the Bank could face uncomfortable questions if the trend continues.

"The BoE once again faced difficulties in finding sellers of longer-dated gilts during yesterday’s QE operations (with the average tail increasing to 83p from 11p); a lack of QE rebalancing may be offering some support for GBP," says Viraj Patel at ING in London.

Indeed, should the quantitative easing programme fail, then Sterling will likely find a strong bid.

A reverse auction is when the buyer does not do the bidding, but makes a request for something.

The buyer then asks sellers to 'bid' for how much they want to sell the item requested; the buyer then selects the best deal.

The auction on Tuesday the 23rd was for longer-dated government bonds of over 15 or more years maturity.

This means that whoever sells the bond has 15 years or more to repay the principle.

Due to the longer time before getting their money back and the higher risk they will not see their money again, sellers are recompensed by a higher yearly interest payment, or coupon in bond jargon.  

The problem for the Bank though is that in a world of low yield, investors tend to hold onto high yielding assets, and remain stubborn to parting with them.

At the BoE’s first reverse auction of 15+ year debt on August 9 the bank failed to buy as much as it wanted, falling short by 52m, however, that was from a 1.17bn target, and it did manage to make 1.11bn of purchases.

The bond reverse-auction failure led to a sudden steep fall in bond yields which had the effect of strengthening the Pound as markets bet that the Bank of England would struggle to implement their gargantuan £60BN quantitative easing programme.

Watch next Tuesday's reverse-auction's cover ratio for the latest chapter in what could well be a big deal for Sterling going forward.

Wednesday's reverse-auction for 7-15 year bonds found no problems with cover as the ratio was seen at 3.10, up from a prior 2.85.

This confirms the questions with regards to the long-dated bonds.

PIMCO See Limited Impact of Brexit

Another boost for GBP has been provided by Mike Amey of Pimco who has commented on post-brexit vote Britain and says that although the hits have been obvious, the impact on consumer and business confidence has so far been limited.

However, "there may be some longer term knock-on effects as import prices go up and inflation goes up - that's going to put pressure on real wages, so I think there's a short-term risk, and then there's a medium term drag on the economy," says Amey.

PIMCO's expectation is for expectation is for growth to fall to just above zero over the next 12 months before recovering back towards the 1.5% to 2% levels we had ahead of the Brexit vote.

This outlook was predicated on a protracted set of negotiations over the UK exit from the EU, a modest slowdown in consumer spending and a more significant slowdown in business investment.

"We expected a monetary response and got one, and we expect a fiscal response as well. We see little reason to change those assumptions or expectations," says Amey.

So if quantitative easing isn't finding the necessary sellers, and the economy is actually ticking along just fine, surely further action from the Bank of England is not warranted.

If this theme grows in popularity, expect GBP to recover.

Sorrell Turning Positive on UK Economy Again

The British Pound enjoyed a strong rally so far this week, and on Thursday the 25th August it appears the challenge will be to defend those advances. 

Strength has come against the Euro, US Dollar and the rest of the G10 complex thanks to a positive flow of economic data communicating to traders that the UK economy may not suffer those declines the Brexit vote was anticipated to deliver.

Indeed, on Thursday we hear that Sir Martin Sorrell, a vocal opponent of Brexit, has said the UK economy is "perking up."

Sorrell, the architect behind marketing and advertising giant WPP, and therefore someone who has his finders on the pulse of business sentiment, says "what we saw after the vote – and it's only July, we haven't got the numbers for August – was the UK perking up a bit."

For the UK economy, and therefore the Pound, we believe the question of how hard the Brexit vote hits is largely down to a question of confidence.

Yes, there are some big trade challenges, as our series on a post-Brexit Britain reflect, but this is by no means a crisis.