Higher interest rates and quantitative tightening may add to the risk of another financial market shock, according to the Bank of England’s executive director for financial stability.
(Bloomberg) — Higher interest rates and quantitative tightening may add to the risk of another financial market shock, according to the Bank of England’s executive director for financial stability.
Sarah Breeden said that as long as rates remain elevated, the BOE’s Financial Policy Committee needed to be alert to risk of another blow up following last year’s LDI pensions crisis.
“Tightening monetary policy after a long period of very low rates has the potential to reveal further financial vulnerabilities,” she said in a speech in Leeds. “While we don’t yet know how long higher interest rates will persist, it’s clear that the FPC will need to continue to be alive to potential financial stability consequences.”
The central bank bought almost £19.3 billion ($22.9 billion) of long-term government debt following then-Prime Minister Liz Truss’s disastrous budget last year.
The BOE stepped in to prevent a shock in the gilt market from turning into an economic crisis. The intervention was a success, with the BOE offloading all the gilts within three months for a £3.5 billion profit.
Breeden, who is a contender to replace Jon Cunliffe as deputy governor for financial stability when he steps down later this year, said “the LDI episode highlights the need for vigilance” particularly in less regulated market-based finance.
“As monetary policy makers gradually implement QT, financial markets will adjust, perhaps in unexpected ways,” she said.
Breeden added that the BOE wants to create new economic models that capture the “interactions between monetary policy and financial stability. My hope is that we can eventually create tools that will help both committees think about issues which span both objectives.”
The LDI crisis was a moment when financial stability and monetary policy appeared to be acting at cross-purposes, as one arm was buying gilts as the other planned to sell them.
Breeden said: “While there may have been a difference in direction of policy – buying versus selling gilts – the goals were complementary. Stabilizing the market also supported the conditions for monetary policy to be carried out as normal.”
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