Observers will be nervously eyeing the Bank of England’s (BoEs) meeting on Thursday, as aside from its latest decision on interest rates the central bank could also unveil details on when, and how, it could begin tightening its current stimulus measures, many of which have been in place since the 2008 global financial crisis.
A review by the BoE into a possible tightening has been in the works since February and will be published before the end of the year. The bank has said the review will include a strategy of how to organise a rise in interest rates, which are currently at a record low of 0.1%, as well as a timetable on how it plans to sell government bonds purchased as part of its quantitative easing (QE) programme, which has run into the hundreds of billions.
The biggest focus for investors when the review is finally published will be the threshold at which the BoE will start to sell bonds into the market, reversing its current buying policy.
This event hinges on the BoE’s bank rate threshold, the interest rate a central bank charges to domestic banks to borrow money from it. Currently, the BoE’s policy is that it will not sell bonds until the bank rate reaches 1.5%.
However, a Reuters report said options for the BoE in its review could include lowering its threshold to a conservative level of between 0.5-0.75% to begin selling off bonds, however, markets have not priced in rates such as these until late 2023 at the earliest.
More radical predictions have included the BoE cutting the threshold to 0.25%, which would allow it to reverse QE in late 2022, or even scrapping the threshold altogether which would allow the BoE to begin selling bonds early next year, potentially before raising interest rates.
However, while removing the threshold may prove popular with monetary policymakers, some analysts may be worried such a move could derail the economic recovery by pushing up borrowing costs.
Another potential strategy would involve the BoE not buying new bonds rather than selling any of its current holdings, although varying maturation dates on the purchased bonds could lead to an uneven rate of policy tightening as different amounts of bonds matured in different years.
End of support raises fears of cliff-edge
The potential unwinding of the BoE’s QE programme, as well as possible interest rate rises, may raise anxiety in the market about a potential economic cliff-edge in the third quarter as pandemic support measures begin to end in many.
The end of the UK’s furlough scheme, as well as the tapering of business rates relief and the stamp duty holiday over the coming months may have some observers worrying that issues around unemployment and struggling businesses could erupt simultaneously once the support measures are removed.
READ: Post-COVID cliff edge: End of support measures raises fears of rocky third quarter
Interest rate hikes in particular are a cause of concern given an ongoing debate about whether rates need to be raised to reduce the possibility of rampant inflation.
However, a rise in rates would likely increase the cost of servicing the already large amount of debt swirling around the UK economy, particularly among small businesses, although the Treasury may be hankering to bring inflation under control as certain pledges, notably the triple-locked state pension, are likely to see billions in extra spending added due to being tied to inflation rates.
The issue was thrown into sharp relief by the government’s latest borrowing figures, which saw a record jump in the state’s interest payments to £8.7bn in June as a result of inflationary pressures.
The decision for the BoE may therefore morph into a trade-off, pile the pressure on businesses servicing debt by raising rates or tighten the screw on the state by keeping rates low and risk continued high inflation.