Recommendation 20

HM Government Deferred

As the Committee refers to in their report, there are a set of important issues the Bank is likely to face as APF unwind continues. Across several speeches, former Executive Director for Markets at the Bank, Andrew Hauser, set out these challenges including supplying the right amount of central bank reserves to the market, transmitting the MPC’s policy rate decisions into the real economy, and doing so whilst maintaining financial stability. The market notice issued by the Bank in August 2022 outlined the mechanics of the Bank’s planned APF gilt sales, as well as the Bank’s new Short Term Repo facility (STR) and the potential long run composition of assets on its balance sheet. The APF unwind profile will continue to be determined by the independent MPC. As has been the case, subject to the MPC’s policy objectives, the Bank’s operations in respect of the APF and its unwind will continue to be governed, designed and risk managed with the aim of minimising cost and risk. These are important issues and the Treasury is engaging with the Bank on them, including to understand both the short and long-term implications arising from material changes to the Bank’s balance sheet and how the Bank will meet its statutory monetary policy and financial stability objectives. As in the UK, major central banks internationally are reviewing the future shape of their balance sheets. Any changes will be communicated at the appropriate time. The recommendation in paragraph 20 states that the Bank and Treasury should clarify the future arrangements for the steady state level of reserves, including the future of QT at that point. It is important to note at the outset that QT is only one factor behind the normalisation of the Bank’s balance sheet. Reserves may also fall for other reasons, most notably repayments of loans made under the Bank’s Term Funding Scheme with additional incentives for small medium-sized enterprises (TFSME). Nevertheless, a reduction in the size of the APF has implications for the level of reserves in the system. In September 2022 the Bank set out its arrangements for allowing the MPC to focus solely on monetary policy considerations in setting its strategy for unwinding its stock of asset purchases. These arrangements are designed such that the MPC could, over time, if it judged this necessary for policy reasons, unwind the APF fully in line with the gradual and predictable approach that it has previously articulated. It does not state that QT would cease at a certain level of reserves, nor would it rule out other choices. To maintain control over short-term market interest rates during this period and in order to implement monetary policy, the Bank announced a new market operation in the same market notice–the Short Term Repo Facility (STR)–that allows commercial banks to borrow unlimited reserves at Bank Rate against gilt collateral on a weekly basis. In addition, we expect usage of the full set of our liquidity facilities to rise as the level of reserves in the system falls. At the point that reserves reach the minimum desired level, banks will be able to meet their demand for reserves at Bank Rate using the Bank’s liquidity facilities, stabilising the quantity of reserves and allowing the MPC to decide to continue reducing the stock of assets held in the APF for monetary policy purposes, should it judge that necessary for monetary policy reasons. The quantity of reserves needed to maintain monetary control and financial stability once QT has completed and TFSME drawings have been repaid is likely to be substantially higher than in the past. The Bank is continuing to analyse the optimal steady state level of reserves for monetary and financial stability, as discussed in more detail in a recent speech by Andrew Hauser, among others. In addition to this, the recommendation in paragraph 4 asks the Bank to develop its planning on the long-term steady-state size and composition of the balance sheet. The Bank is currently undertaking work to determine the appropriate long-term mix of assets to hold on its balance sheet. Decisions on the asset mix have implications for the Bank’s policy objectives, and risks to the public sector balance sheet. Decisions on the size and shape of our future balance sheet will be made in close consultation with HM Treasury and relevant stakeholders and communicated in a transparent manner.