LONDON, Oct 27 (Reuters) – Central banks could be forced to rethink and even undermine one of their valuable emergency policy tools as popular resistance mounts against giant cash transfers to commercial banks as governments interest rates rise, the recession deepens and treasury coffers empty.
The stakes are high because it potentially affects the future use and effectiveness of extraordinary monetary policies such as bond-buying “quantitative easing” (QE) and calls into question the broader political independence of the EU. central bank policy making.
The European Central Bank, Bank of England and US Federal Reserve are all – to varying degrees – facing a backlash from years of policy-driven but lucrative balance sheet expansion. As they raise interest rates, that record burns a hole in their pockets – or more specifically in the pockets of their governments long accustomed to windfalls coming the other way.
It’s the flip side of more than a decade of bond-buying QE – introduced to overcome near-zero policy rate limits when deflation fears dominated and which offered banks billions of dollars in interest-bearing reserves in exchange for bonds.
With rates falling or near zero, central banks have made money on this change by accumulating higher-yielding bonds, paying next to nothing on commercial bank reserves, and transferring the accounting profit that results in governments to spend them.
Now that they are forced to raise interest rates sharply before significantly shrinking these balance sheets, swollen further by pandemic-related support, a massive payday for banks is in sight as remittances to Treasures dry up and even reverse.
The optics of these payments to banks while taxpayers pay the hook can prove politically toxic.
“Paying banks billions to hold the safest form of liquidity possible may trigger public criticism,” wrote Axa Group chief economist Gilles Moec, adding that it could be seen as a “ undue support” when rising rates are already increasing banks’ net margins and when the public treasury is being squeezed by a series of shocks.
Britain has struggled with this problem all year. read more read more read more
After paying some £120bn in profits to the Treasury over 13 years, the Bank of England last month suffered its first loss to public finances since it launched its QE program in 2009 – a monthly loss of £156m pounds on its bond portfolio compared to interest paid on reserves.
This will surely rise as the BoE is expected to at least double its key rate, the rate paid on bank reserves, by May. Paul Tucker, the former deputy governor of the BoE, called on the central bank this month to cap the rate it pays on those reserves, and estimated it could save around £40bn the government is now desperately looking elsewhere for its revised November 17 budget statement. .
And after more than $100 billion in transfers to the Treasury last year alone, net Fed income also turned negative in September and will continue to do so for some time as reserve payments increase.
On Thursday, the ECB may well reveal how it plans to handle the gauntlet.
WAR AND PEACE
With a total of nearly 5 trillion euros in excess reserves, the ECB is expected to address how its rising deposit rate allows commercial banks to use the central bank as an ATM, funding facilities for round-trip emergency with rates now lower than those obtained by simply depositing the cash back at the ECB.
ECB watchers believe that a solution could be a form of “reverse tiering” of the payment of reserves linked to amounts drawn down in so-called targeted long-term refinancing operations (TLTROs) – which represent around a quarter of the ECB’s balance sheet. ECB.
While this may well end up being the least worst option, it poses multiple problems – not least the precedent of retrospectively changing the original terms and conditions of TLTRO loans and potentially clouding their uptake and effectiveness if needed in a future downturn or other shock.
Unicredit’s economic adviser, Erik Nielsen, described this option as “a seriously inconvenient path”.
Goldman Sachs rate strategist Simon Freycenet believes that adjusting the terms of the TLTRO to bring that funding rate closer to the ECB’s deposit rates was probably the “least complicated solution” – but it had “downsides”. obvious in terms of future political and legal risks”.
The cost of doing nothing is hardly an option. Axa’s models show that raising ECB rates to an expected peak of 3% next year would imply an excess reserve shock that depresses the eurozone fiscal balance by 1% all at once.
All of this underscores the direct fiscal effect of QE monetary policy which many feared would complicate a complete exit from QE when policy rates need to soar to calm inflation – threatening central bank independence and their mandate to focus solely on price stability when government policy and budgetary pressures demand the opposite.
Kenneth Rogoff, the former chief economist of the International Monetary Fund, this week reaffirmed his argument that the Fed should have considered negative interest rates rather than doubling down on a QE program that is now politically harder to reverse.
“For all their complaints about inflation, one wonders how prepared voters are for another deep recession,” Rogoff wrote in Foreign Affairs. “The changes in the political and economic landscape have become so profound that it seems unlikely in the foreseeable future that the Fed will choose to return inflation to pre-pandemic levels and keep it there.”
For Nobel laureate Joseph Stiglitz, the political imperatives of the war sparked by Russia’s invasion of Ukraine – responsible at least in part for soaring inflation and interest rates this year – should reasonably dominate narrower market objectives and prevail over opposition to the use of windfall taxes, as they have done in all previous major wars.
“It is a mistake to think that war can be won with a peacetime economy,” he wrote on a Project Syndicate blog. “No country has ever prevailed in a serious war by leaving the markets alone.”
The opinions expressed here are those of the author, columnist for Reuters.
by Mike Dolan, Twitter: @ReutersMikeD. Reporting by Nell Mackenzie; Editing by Paul Simao
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