U.K. investors are looking east to work out what more the Bank of England may do to help support the country’s coronavirus-addled economy.
While the central bank is widely anticipated to focus on expanding its quantitative-easing program on Thursday, speculation is building that it will impose yield-curve control — a policy pioneered by the Bank of Japan — in the coming months.
The aim would be to target specific levels in its buying of government bonds, stifling increases in borrowing costs. That would help the government finance its massive support package to revive economic growth at a low cost for a long time.
For traders, the key would be which bonds the BOE decides to peg and at what level. Existential questions surrounding the future of trading the securities would emerge, especially if their scope for movement is limited. In Japan, there have been days where not a single government bond traded at all.
The success of the policy in Japan is debated among economists, with the country still battling anemic growth and inflation, even before the coronavirus pandemic. Nevertheless, the BOE under Gov. Andrew Bailey is running out of conventional tools and is exploring the possibility of negative-interest rates — a policy adopted by the BOJ and the European Central Bank.
“Yield-curve control is more likely than negative rates in the U.K.,” said Adam Dent, a U.K. rates strategist at Banco Santander SA. “It is a reasonable and effective policy, and the new BOE under Bailey may well be open to more radical changes to policy tools than before.”
The growing clamor that more stimulus may be needed comes after the U.K. economy shrank a record 20.4 percent in April, with the contraction over the last two months wiping out almost 18 years of growth. But the U.K. isn’t the only central bank that may adopt yield-curve control.
Market watchers expect the U.S. Federal Reserve to bring in a similar measure later this year, with Chairman Jerome Powell indicating last week that interest rates were unlikely to climb any time soon. The ECB has acknowledged the importance of keeping borrowing costs low across all bond maturities, without committing to an explicit yield curve control policy.
“If you have to think about what’s the most likely central bank to go down the route of yield-curve control, is it the BOE or the ECB, it’s got to be the BOE,” said George Buckley, an economist at Nomura International PLC. “There’s a lot of risks around negative rates.”
The negative rates option could harm banks’ profitability, and no country that has implemented the policy has managed to lift rates above 0 percent. In addition, yield-curve control may also prove to be more cost effective for the BOE than continually boosting its bond-buying program, which currently stands at £645 billion ($810 billion).
Right now, U.K. bond yields are already hovering close to their lowest levels in history. The rate on benchmark 10-year gilts is at around 0.2 percent, while those on two-year securities are already below 0 percent.
HSBC Holdings PLC’s head of U.K. rates strategy Daniela Russell sees five-year bonds as the most likely target for yield-curve control — at the current bank rate of 0.1 percent — given that most businesses borrow short-term. Policymakers could use it to help issue forward guidance to the market, she said.
Yield-curve control has also been discussed by a think tank in vogue with U.K. Prime Minister Boris Johnson’s Conservative Party. The Policy Exchange issued a report this month recommending targeting the 10-year yield, in an effort to lower the cost of the debt stockpile. It highlighted that the U.K. has a longer average maturity than most of its peers at around 15 years.
Bank of America Merrill Lynch estimated that the BOE’s stock of debt will exceed over £1 trillion of gilts — equivalent to around half of the U.K.’s economic output — just after the new year should it maintain its current pace of QE purchases.
“You don’t want to go down the route of continuing to buy loads and loads and loads if it’s not doing the trick,” said Nomura’s Buckley.