Analysis: BOE Intervention Helped Govt But Like RBA Its Focus Was MonPol

• Published on
• 23 Jun 2020, 02:36 PM

By Sophia Rodrigues

Much has been made of the Bank of England governor Andrew Bailey’s comments at an interview on Monday that in the worst scenario the UK would have struggled to fund itself in the short run, and the central bank’s intervention helped avoid that situation.

I think stories suggesting the UK nearly went bust or came close to effective insolvency were misguided because if that’s the case, it was true for many other countries which are relying on market borrowing to fund their deficit.

It would be true for India and it would be the same for Australia.

Central banks in these countries also intervened. Their actions, like that of the Bank of England, were aimed at meeting their monetary policy objectives, but they were directed at the risk-free yield curve.

This is not new.

RISK-FREE YIELDS UP

What happened in financial markets in March was extraordinary, and along with other markets, the government bond market was badly hit.

As recently as Monday, RBA governor Philip Lowe said central banks were sharing information and comparing notes when the crisis began, and in March and April their discussions were about “extreme volatility in markets and worryingly the dislocation in government bond markets which were affecting the risk-free yield curve everywhere around the world.”

It is well-understood that when markets are dislocated, investors demand higher yields to compensate for higher risk.

It is the same for the government bond market and tenders are cleared at higher cut-off yields, or higher weighted average yields.

In extreme cases, tenders do not receive enough bids. That’s when you say the government has not been able to fund itself.

But when risk-free yields go up, it also affects the central bank’s monetary policy because other interest rates in the economy also move up. So effectively, there is a tightening in monetary policy and the central bank acts to loosen policy, so it remains on track to meet its mandate.

NOT DIFFERENT IN AUSTRALIA

That is what Bank of England did back in March. Its actions were aimed at meeting its mandate, but they were directed at the government bond market. It helped the debt manager’s borrowing task.

It was the same in Australia. The government’s policy actions meant a big rise in borrowing task for the Australian Office of Financial Management. This, together with dislocation in markets, led to rise in yields at bond tenders.

To mitigate its risks, the AOFM stepped up borrowing via Treasury Notes because it is easier to attract investors for short-term instruments.

In the UK, they went a step further. The HM Treasury and the Bank of England announced temporary extension to Ways and Means facility. This will provide short-term source of additional liquidity to the government if needed to smooth its cashflows and support the orderly functioning of markets, through the period of disruption from Covid-19.

A facility like this is not necessarily established to meet situations where the government is not able to borrow from the market. It is useful when there is a risk of yields moving up sharply at tenders, so instead of tapping the market, the Ways & Means facility is accessed.

BOE’S VLIEGHE PUT IT WELL

What the Bank of England has done or what other central banks like the RBA has done is well-summarised in a speech by BOE monetary policy member Gertjan Vlieghe in April.

“Central banks use their balance sheets to achieve monetary policy objectives. In doing so, they affect government finances. That has always been the case, and that continues to be the case. This in no way detracts from the central bank’s independence and its ability to hit the inflation target,” Vlieghe said.

Referring specifically to Bank of England Vlieghe said, “The MPC judged that the tightening in financial conditions that was underway would have caused an unwarranted reduction in aggregate demand and hinder progress towards meeting the inflation target, hence it was appropriate to act.”

--Contact: Sophia@centralbankintel.com