Wednesday, March 25, 2009
Bank of England "failed auction:" Some perspective
Lots of talk today about a "failed" gilt auction in the U.K. and what that might portend for the U.S. Treasury market. Many commentators saying that it's only a matter of time before the U.S. experiences what just happened in the Britain.
However, those making that prediction are ignorant of the facts. Remember, monetary policy is all about price, not quantity. The price is the interest rate. Once a central bank sets an interest rate target it is obligated to sustain a level of reserves that maintains that rate. Remember, too, that the reserves provided by the central bank are the funds used to buy Treasuries or in the case of Britain, gilts.
The Bank of England still mainains a positive interest rate of 0.5%. While this is low, it still requires reserve maintainence to keep it there. On the other hand, the Fed's overnight interest rate is zero and it has been aggressively targeting long-term rates lower as well.
This means that the Fed has been far more aggressive in boosting system reserves or, providing the money to pay for Treasuries. The Bank of England has not.
One glance at the chart below should make it clear.
While the Fed has manipulated reseve balance up by almost 8,000% in the past year, the Bank of England reserve growth has been only about 120% over that course of time and has recently dropped down significantly. If the central bank is not providing the funds to buy gov't securities (or if the British treasury is not providing the funds), then the money to buy gilts will not be there. Thus, the "failed" auction. It's the market's warning to the BOE and the British government that either interest rates must be lowered to zero or more gov't spending must be undertaken.