Is Quantitative Tightening Causing a Cash Crunch for BoE?

Exploring the realm of central bank reserves and the recently created Short-Term Repo (STR) program by the Bank of England is crucial. It investigates if this instrument is pointing to a possible problem with the Bank’s strategy to use quantitative tightening to reduce the size of its balance sheet.

Background

The Bank purchased assets, primarily government bonds, as part of Quantitative Easing (QE), which injected cash into the economy. Commercial banks now hold a larger portion of central bank reserves as a result. By selling assets and allowing reserves to mature, the Bank reduces the size of its balance sheet through Quantitative Tightening (QT).

Essential Issue

The “Preferred Minimum Range of Reserves” (PMRR), as it is known, is the range of reserves that banks are estimated to need. There is worry that banks may run out of reserves as QT goes on, which might lead to financial instability. Banks can borrow reserves from the Bank of England on a weekly basis under the Short-Term Repo facility.

Recent Developments

Given the Bank’s sizable balance sheet, usage of the Short-Term Repo facility has unexpectedly increased. This begs several questions, such as: Do banks genuinely require greater reserves than previously believed because the PMRR is bigger than predicted? Do certain banks have a disproportionate amount of reserves, leaving others short?

BoE’s Response

The Bank of England is pleased to see more people using short-term repo. For longer-term borrowing requirements, they are pushing banks to use the Indexed Long-Term Repo (ILTR), a distinct facility that they intend to make more appealing. It’s also critical to recognize that the financial system is complicated and that there are no hard and fast solutions.

It would be beneficial to keep an eye on the usage of short-term repos to see if it keeps increasing and if the Bank has to make any adjustments to its QT plans.

Although the Bank of England is reducing the size of its balance sheet, it is unclear how much reserve banks will actually require. Though the precise cause is unknown, a spike in borrowing from the Short-Term Repo facility points to possible problems. The Bank of England is pushing alternative methods of reserve management. To ascertain whether quantitative tightening needs to be modified, further data is required.