In a historical move, the Bank of England announced this morning that it will begin to finance the short-term needs of the Treasury, in other words it will directly monetize the UK deficit, something central banks had - for the past decade - denied they do or would do.
The BOE move will allow the government to bypass the bond market entirely until the Covid-19 pandemic subsides, financing unexpected costs such as the job retention scheme where bills will fall due at the end of April. Ironically, as the FT notes, although BoE governor Andrew Bailey opposed monetary financing earlier this week, Treasury officials felt it was best to have the insurance of the central bank willing to finance its operations in the short term.
In a statement on Thursday, the government announced it would extend the size of the government’s bank account at the central bank, known historically as the “Ways and Means Facility”, which normally stands at just £370m. This will rise to an effectively unlimited amount, allowing ministers to spend more in the short term without having to tap the gilts market. In 2008, a similar move saw the facility rise briefly to only £20bn.
And so helicopter money has arrived, with the UK Treasury now taking de facto control of the central bank.
The Ways and Means facility had long been used as a financing means of government for day-to-day spending before the BoE would sell government bonds to the market, but by 2006, it had become an emergency fund with the financing of government undertaken by the Debt Management Office on a scheduled basis. Less than a month ago, the Bank of England said there was little chance there would be any need to use the facility, demonstrating just how much stress government finances have come under in the past few weeks.
In a call with journalists on March 18, Mr Bailey said the facility was just a “historical feature”.
"I don’t think at the moment we’re facing an inability of the government to fund itself, so, yes, it’s there, but it’s not a frontline tool," Bailey said just weeks ago.
Then, just a few days ago, the governor pledged not to slip into permanent monetary financing of the government in a Financial Times op-ed. Well so much for central bankers having any insight into what will happen in the future... or even in just a few days.
The move highlights the extraordinary demands on cash the government has experienced in recent weeks, which it feels it cannot finance immediately in the gilts market.
The scale is likely to be large. The government has already tripled the amount of debt it wanted to raise in financial markets in April from £15bn announced in the March 11 Budget to £45bn by the start of this month.
Although the gilts market showed severe stress in the middle of March as the coronavirus crisis deepened, the government has so far had little difficulty raising finance, especially as the BoE had already committed to printing £200bn to pump into the government bond market to ensure there was sufficient demand for gilts and improve market functioning.
This direct monetary financing of government would be “temporary and short-term”, the Treasury said in its statement.
"As well as temporarily smoothing government cash flows, the W & M Facility supports market function by minimising the immediate impact of raising additional funding in gilt and sterling money markets."
Market reaction was muted. Sterling was trading 0.1 per cent higher against the US dollar at just below $1.24 shortly after the announcement, while the yield on the benchmark 10-year UK gilt was flat at 0.37 per cent.
However, While the BoE stated that the debt monetization would be “temporary and short-term”, it will be no such thing. Richard Barwell, head of macro research at BNP Asset management and a former BoE official, said temporary moves such as this often became more permanent as time passed.
"Persistent monetary financing feels inevitable. Central banks just need to figure out a plan for how to best get into it and how they might eventually want to get out of it," he said.
Tuomas Malinen of GnS economics however put it best:
It would result in the complete socialization of the capital allocation process. The last time this happened on a systemic scale was in the former Soviet Union, a socialist controlled-economy experiment and global superpower which existed from 1917 till 1990. The thing to remember with socialist experiments is that they always concentrate power—economic and political—in the elite.