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Bank of England Acknowledges the Potential Disaster of Central Banks Unwinding QE Asset Purchases


Imagine if the Federal Reserve ever made this kind of statement.

MINYANVILLE ORIGINAL This morning, the Bank of England announced that it would transfer the coupon payments it had received from the UK government on its QE purchases back to the government. The goal of this return of money is to pay down the UK's existing debt. Frankly, this is not a new development among central banks and governments around the world (the Fed and Bank of Japan both do this). Some may point to this as monetary financing of governments, which it arguably is, but that's what QE is to begin with.

The dilemma is this: You can have the Bank of England, or any central bank in general, keep these interest payments on asset purchases they receive as profits, making the central bank a for-profit organization, or you can have them disburse this money back to the country, as they rightfully should. (To me, a central bank that is run like a for-profit organization opens up a whole litany of scary possibilities.) Disbursing the funds is also an added bonus for the bank's QE program, a direct injection into the government, like landing on "GO."

One thing that was refreshing to hear was the BoE's Monetary Policy Committees' (MPC) outlook on unwinding its QE holdings. The committee noted that as interest rates rise, the BoE will realize losses on its holdings of British gilts, and the UK Treasury will need to cover the losses. This is something that Fed officials haven't even dared to utter. The Fed's QE holdings are roughly six times ($556b vs $2.85b) that of the Bank of England's. If the market so much as got a sniff that the Fed was going to sell or unwind its holdings of Treasuries, the consequences and hyperinflation that could follow is a sobering prospect. The Bank of England, however, realizes the potential backstop that the UK Treasury would need to provide to its central bank given the current scenario, and so far the task appears manageable due to the size of the central bank's purchases relative to the total market size.

Can you imagine how that would happen in the US? Imagine Ben Bernanke calling up the Treasury Secretary, "Uhh, Mr. Secretary, we need a trillion bucks from the Treasury because we're in the hole for all of our QE purchases. And, oh yea, we might lose the US dollar as the reserve currency." And if pigs could fly... .

The result of today's action? The GBPUSD has dropped to 1.5910 from 1.6000 (the dollar is up 0.20, so not a total pound sell-off). The 10-year gilt has dropped from 1.77% to a low of 1.67%, but now trades at 1.73%, on the idea that there will be 35 billion pounds less gilts in circulation.

Twitter: @MichaelSedacca

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No positions in stocks mentioned.

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