In March, the Bank of England hoovered up ₤15.3 billion of government debt. Everyone else was happy to sell. On a net basis, the BoE was the only institution that actually accumulated any holdings of government paper. These purchases were, of course, the infamous quantitative easing, which the Bank is using to affect monetary conditions, given that the bank rate is close to zero.
Lets remind ourselves why the Bank of England began creating money. This strategy is supposed to improve liquidity conditions, reduce interest rates, and lead to higher lending. However, government yields have actually crept up in recent weeks. So, what is going wrong?
The answer lies with who is buying the debt. The biggest sellers of government paper were non-residents. This raises a troubling question; if an foreign holder of a UK government bond sells to the Bank of England, how does this help liquidity conditions in here in the UK?
The second largest seller were non bank resident investors. Again, it is not entirely obvious how these sales helps credit growth. It might help to the extent that the proceeds of these sales are placed in UK banks. However, yields on bank deposits are lower than government debt, so that would appear to be an unlikely destination of the funds.
I am going to take a wild guess and suggest that the proceeds of these sales went into equity markets. Over the last few weeks, equity markets, including the FTSE, have enjoyed a healthy recovery.
The suggestion here is not that quantitative easing is the primary cause of the equities recovery. Rather, it is that as equity prices have increased, bond holders have an incentive to sell government paper to the Bank of England and move the funds to equities. This pushes up equity prices further, pulling money from the bond market, raising yields on government debt.
So far, the QE strategy has been riven with inconsistencies. The initiative was supposed to help corporate lending. However, the bank has bought government paper instead. Very little of the new money has gone into banks. Most of it has gone out the door or into the equity markets.
One thing is for sure, within about 18-24 months, this massive, historically unprecedented expansion of high powered money will lead to rapidly increasing prices.