In times of global crisis, central banks watch for signs of panic in the financial markets. On 3 March 2020, when it became clear to investors that Covid-19 posed a significant threat to the global economy, a sudden flight to safety threatened to turn into a full-scale stampede.
With sellers dramatically outnumbering buyers, central banks found themselves riding to the rescue.
In Britain, the Bank of England spent £200bn in its role as buyer of last resort. This week the Bank will attempt to draw a line under the pandemic by becoming a seller again, albeit by simply not repurchasing government bonds it currently holds.
On 7 March, about £30bn of UK gilts will mature and the Bank will allow other investors – probably insurance companies and banks – to buy them, rather than reinvesting the proceeds itself. Officials in Threadneedle Street are also expected to make progress offloading £20bn of loans to big corporations that made up a small slice of the £895bn in quantitative easing it has utilised since 2008.
Within the next few months the value of the QE programme, which was started in response to the 2008 banking crash, will have dropped to £847bn, which is still much higher than its pre-pandemic total, but heading in a direction that appears to show normal, pre-pandemic service from the central bank being resumed.
So far the war in Ukraine and the sanctions imposed on Russian banks and oligarchs is not enough to make Threadneedle Street change course. But Andrew Goodwin, chief UK economist at consultancy Oxford Economics, says the conflict will make the Bank more cautious.
After the March sale, only £9bn of the remaining £847bn will be left still to mature in 2022, which means the Bank will need to actively sell bonds if it wants to make a large dent in its QE debt pile.
“UK banks are not showing any signs of stress, so the current plan is likely to remain in place,” Goodwin says. “But the lack of maturing bonds means the bank will need to be more proactive to keep up the momentum, and with the current uncertainties, sales are likely to be limited.”
The war will probably have a bigger effect on interest rates, which he thinks might now increase by only 0.5 percentage points to 1%, and stay there. Before the Ukraine invasion, investors were expecting interest rates in the UK to hit 1.75% by December and 2% by the middle of next year.
Goodwin says governor Andrew Bailey’s fears over workers securing inflation-busting wage rises over the coming months, triggering a wage/price spiral, are unlikely to materialise and that the main impact of higher gas and oil prices will be to cause a severe hit to household finances.
Consumer confidence surveys were indicating before the war started that shoppers would be keeping their wallets shut while they coped with rising bills, taxes and interest rates.
Between 70% and 80% of GDP growth is accounted for by consumer spending, and the recent fall in measures of confidence signal that economic growth could slow or go into reverse – even without further interest rate rises.
The same pressures are bearing down on the European Central Bank, which meets on Thursday. George Buckley, economist at Nomura, thinks the ECB is likely to “put on ice” any threat of higher interest rates.
ECB president Christine Lagarde is also expected to leave in place a schedule of monthly additions to QE that is on course – but will see additions reduced from €40bn to €30bn in the third quarter and €20bn from October onwards.
However, a prolonged war that spurs the west to slap more sanctions on Russia and Belarus will hand Lagarde and her counterparts in the Bank of England and the US Federal Reserve a huge dilemma.
Salman Ahmed, global head of macroeconomics at stockbroker Fidelity International, says it amounts to an “unenviable choice” that will leave them upsetting lots of people.
“The Fed, ECB and Bank of England were already wrestling with higher inflation and slowing growth. The Ukraine war has not changed those fundamentals, but it is likely to exacerbate both. Policymakers are facing an unenviable choice between acting hawkish to get inflation under control at the risk of meaningfully damaging growth, and letting inflation run unchecked in order to protect growth as much as possible.”
