BoE at risk of underestimating impact of QT: T. Rowe Price

by | Sep 19, 2023

By Tomasz Wieladek, chief European economist at T. Rowe Price

The Bank of England (BoE) will likely raise its deposit rate by 25bps this week, as price and wage inflation data have surprised its forecasts to the upside since its August meeting. The BoE expected pay growth to decline to 6.9% by September, but the latest data suggest pay growth could still be running at 8% – more than double the figure necessary to bring inflation back to target. 

However, depending on Wednesday’s inflation data, the BoE could signal it is close to the peak rate. Senior BoE policymakers have recently indicated rates could be close to the top and the preference is to hold interest rates for a prolonged period of time. The MPC could say that the monetary stance is ‘very’ restrictive, rather than just restrictive. 

Indeed, the labour market and real economy data have clearly begun to weaken, with a rapid rise in the unemployment rate from low levels, a decline in the vacancies to unemployment ratio, a drop in employment and a significant fall in July monthly UK real GDP. However, for this to happen, this Wednesday’s August CPI inflation release needs to indicate core and services CPI inflation have peaked and are beginning to turn.

The BoE will also likely accelerate its QT policy from £80bn to £100bn a month. It has had this policy for a year now and concluded the effects on bond markets are small, based on a survey of market participants. However, the BoE and other central banks do not have a good understanding of QT. Actively selling gilts while the government is trying to issue a very high number of gilts can certainly contribute to higher long-term yields. A rapid return of term-premia – the compensation investors require for holding very long-dated government debt – is a risk, where the probability rises the more gilts are removed from the central bank’s balance sheet.

There is a significant risk the BoE has underestimated the economic and bond market effects of QT. This could contribute to monetary over-tightening, as the BoE believes the monetary policy effects of QT are small, and hence does not take it sufficiently into account when setting interest rates.

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