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Unwinding Quantitative easing in the UK, implementation and impact

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TheMotorcycleBoy
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Unwinding Quantitative easing in the UK, implementation and impact

#138597

Postby TheMotorcycleBoy » May 12th, 2018, 6:51 pm

Hi All,

Apologies if this has already been discussed to death on LF, I had a quick look but couldn't find anything discussing the kind of thoughts etc. I'm having, and Google was not a great deal of help either. As a few of you know, myself and Mel, are newbies to these site, and to investing in general. We have asked a few questions and some of the forthcoming discussions evoked the mention of the "unwinding of QE" as being a factor in investment decisions and possible outlooks.

So how exactly do people here think QE will be unwound? And what are the possible implications for private investors?

Now I'm no financial/monetary expert, and what I do (or think I) know about QE in the UK, is that it was a basically a creation of money exercise by the BoE, in order to pump liquidity into the economy, and instead of chucking the money out of a helicopter, the excess money was used to purchase high quality debt (i.e. mainly gilts but also some investment grade corporate bonds). So the after effect being investment banks (presumably they were the prior bond holders), and then others (who could now borrow, and be paid, and spend) had more cash available and the BoE possessing lots more fixed income assets on it's balance sheets.

So how is the above "unwound?". I'm going to volunteer a couple of implementations and would welcome others' opinions on these. Firstly, the BoE could merely sell the assets (those which have not already matured) back to the market. The other way, I suppose, is that as the coupons and principals of the bonds appear as cashflows in the Government's account at the BoE, the Bank can then debit the account by the tune of these values.

Were the first option to be selected then presumably bonds prices will fall, so yields would increase, and if the second were chosen, then I guess the Government would have less money in the Bank, so would have to borrow more, presumably on the bond market and so again bond prices would fall.

Apologies, if the above is way off the mark, we are still just newbies over here, and monetary policy is not our strongpoint!

thanks Matt

tjh290633
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Re: Unwinding Quantitative easing in the UK, implementation and impact

#138635

Postby tjh290633 » May 12th, 2018, 9:24 pm

The obvious way to unwind QE is to start to sell the bonds acquired.

This has two effects, first it abstracts cash from the market into the government's coffers and so should restrict spending by companies and individuals, thereby putting a brake on inflation.

Second, it will allow the government to reduce its borrowing, by buying back or retiring some of its existing debt. This will reduce the amount of interest that the Government has to pay on its borrowings, especially if it concentrated on the higher yield stocks.

So holding back inflation means that government spending will not rise so quickly and reducing interest payments will perhaps hasten the day when the debt to GDP ratio is at a more normal level.

TJH

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Re: Unwinding Quantitative easing in the UK, implementation and impact

#138670

Postby odysseus2000 » May 12th, 2018, 10:43 pm

The consequences of quantitative easing have been debated for nearly a decade now.

One of the prior examples that was referred to as ‘Interest Rate Pegging” was used in the US during the second war to peg interest rates at low levels, and after wards it was removed. Folk who have studied this have long argued that the trade of the century was to short bonds. Folk who followed this thesis have so far been murdered.

Another active line of arguing is that interest rates are too low and must rise. This argument often refers to the 1970’s, a period of high inflation when interest rates were high, but if you go further back then there have been long periods (centuries) of very low interest rates. One side shoot of this line of reasoning is that inflation will rise and interest rates will have to rise to curtail it. The only problem with that is that inflation is about too much money chasing too few goods. What we have now is too many goods chasing too little money, thanks to the Chinese economy, such that politicians worry more about deflation than inflation. Additionally as renewable energies ramp the influence of oil wanes. If we switch to a UK centred view we have the weak pound that is pushing up the price of imports but at the same time cutting the cost of exports and it is far from clear if this is bad or a good force to re-balance the economy.

Yet another line of thought is that debt to gdp is way too high and must be brought down. The problem with this is that the economy does not appear to be troubled by high debt as it is set against high asset values and the ability to service the debt with electronic printing of money has become accepted. This situation could not have existed with the gold standard, but that looks unlikely to ever return. Of the advanced economies only Germany has low debt, a consequence of the weak Euro that has caused German manufacturing to boom. Elsewhere high debt is common.

As far as I can see their is most political consensus towards doing nothing, letting things carry on as they are. Politicians and commentators who complain about high debt are campaigning, the reality is that it doesn’t matter and would only matter if credit levels were downgraded and the economy went into a tail spin, neither looks probable for now.

My advice, based on a long time studying all of this, is to not waste time considering it. If things are to change then equity prices and bond prices will have to adjust and until there are clear signs of this the most profitable techniques, again in my opinion, are to focus on your investments and ignore all of this stuff which is mostly political and fodder for writers who have nothing better to do.

Once I used to regularly read the FT and other financial press and from this research I profited little. Looking at the new trends that are emerging and buying into the companies that are riding them has been far better for my profits.

I would strongly council that most financial writers are worse than not reading as they are folk who got good marks for English and are good at writing convincing articles but rubbish at investments and following them will get you hurt.

Regards,

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Re: Unwinding Quantitative easing in the UK, implementation and impact

#138692

Postby Spet0789 » May 13th, 2018, 1:52 am

One correction to the OP.

Banks owned very few of the bonds bought by the BoE. The sellers were largely pension funds and insurance companies. Other than as so called High Quality Liquid Assets (rainy day liquidity), banks have no need to own gilts. As an earlier poster pointed out, these pension funds and insurance companies then bought new bonds at lower yields.

QE has two intended stimulative mechanisms. First to reduce the interest that companies and consumers pay on their borrowings and so ease the burden of indebtedness. And second to push savings out of low risk bonds and into riskier investments.

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Re: Unwinding Quantitative easing in the UK, implementation and impact

#138702

Postby TheMotorcycleBoy » May 13th, 2018, 7:22 am

Ok, thanks it (QE) is a trick really, where the govt. just increased/restructured it's debt in order that the amount of "narrow money" (or whatever ??) i.e. money that folk can spend/borrow is increased. And the govt. debt just increases as a result.....and of course if our administrations just ignore this debt/gdp ratio, then everything's fine, so long as inflation stays on track.

What I find a little confusing is the somewhat abstracted nature of the BoE + Treasury + Govt. entities, when from the outside, at least to me, they really just seem be one single body.

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Re: Unwinding Quantitative easing in the UK, implementation and impact

#138704

Postby TheMotorcycleBoy » May 13th, 2018, 7:56 am

odysseus2000 wrote:My advice, based on a long time studying all of this, is to not waste time considering it. If things are to change then equity prices and bond prices will have to adjust and until there are clear signs of this the most profitable techniques, again in my opinion, are to focus on your investments and ignore all of this stuff which is mostly political and fodder for writers who have nothing better to do.

I thank you for this, and do largely agree with what you've said. The reason, why I'm trying to research this in more depth, is because, for myself and Mel who have only recently started to invest (i.e. move money from bank accounts, that is not already going into pension schemes) and it looks like very hard work in choosing correctly priced assets. Equity purchase wise it looks like we arrived at (or quite close to) the top of the markets, and it has been tricky for us to make good decisions, and I believe/hope that a lot of companies were bought into were not at the very top. We have also bought some corporate bonds and again they are costly in terms of risk incurred right now.

In order to diversify, and to cover ourselves against market fluctuations we would like to add gilts to our portfolio. I have already discussed this with some LFs already, in particular with regard to their price. So far, we have held off since they do seem somewhat pricy. Indeed I'm even now logging the prices of some week by week to see if I can detect any behaviour.

Now since that QE in the UK was implemented using gilt purchases, I'm curious as to whether the unwinding of this will effect gilt prices. I guess the answer is that they probably decrease, since the govt. will have to roll over it's debt. But of course, the unwinding and debt rollover will (I guess) take place over a long time frame - 10 to 20 years perhaps? And so (as I think you are trying to suggest!) I'm misguided in agonising greatly over it....indeed I imagine the real question is not long it will take to unwind QE, but rather will the next big financial crisis have occured before then!

odysseus2000 wrote:Once I used to regularly read the FT and other financial press and from this research I profited little.

Yes we receive the FT at work, and I glance at it now and again. Some their political articles are interesting, but by and large, I take no/little guidance from it's financial articles.

odysseus2000 wrote:I would strongly council that most financial writers are worse than not reading as they are folk who got good marks for English and are good at writing convincing articles but rubbish at investments and following them will get you hurt.
I agree!

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Re: Unwinding Quantitative easing in the UK, implementation and impact

#138712

Postby johnhemming » May 13th, 2018, 8:49 am

I think it is reasonable to take a view that interest rates may go up at some stage.

Since 2010 the government fiscal strategy has been keep public spending roughly constant in real terms whilst the economy grows to reduce the deficit. Whilst the government has such a plan the interest rates on sovereign debt are likely to remain relatively low. The fact that at some stage the government will be able to reduce sovereign debt is something that keeps a damper on the interest rate.

It is possible, but I would think not probable, that a Labour government would be elected committed to a massive debt increase. That would be likely to increase interest rates and lead to a fiscal crisis (but not immediately).

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Re: Unwinding Quantitative easing in the UK, implementation and impact

#138916

Postby TheMotorcycleBoy » May 14th, 2018, 5:49 am

1nv35t wrote:
Melanie wrote:What I find a little confusing is the somewhat abstracted nature of the BoE + Treasury + Govt. entities, when from the outside, at least to me, they really just seem be one single body.

All about transparency and supposed political independence. BoE are under remit - such as targeting a 2% inflation rate, and have to account to the government - such as writing a note to explain why that 2% target might currently being missed and what policies are being adopted to correct that, if the deviation is outside certain limits. If a more extreme government attempted to push through inappropriate monetary policies then the BoE could resist such extremes. Government primarily serves the social and economic needs of the country, the Treasury deals with collecting taxes and paying the governments bills, the BoE primarily looks to keep the Pound valuable and our financial system healthy, working closely with the Treasury to achieve that. A Treasury member for instance sits in on the Monetary Policy Committee meetings - but doesn't vote. Four of the nine members are external members (appointed by the Chancellor).

Thanks again. That makes sense.


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