Is the Bank of England’s quantitative tightening causing problems for banks?
Lenders have been increasing their use of the Bank of England’s short-term lending facility over the past few weeks.
Last week, investors borrowed over £16bn from the Bank’s short-term repo facility, setting another record for the facility’s use. Early last month, banks tapped just £5bn in the week.
The facility, introduced in October 2022, allows banks to borrow unlimited amounts of reserves at the Bank Rate, using gilts as collateral.
The purpose of the facility is to keep money market rates close to the Bank Rate while the Bank drains liquidity from the financial system through its quantitative tightening (QT) programme.
Over the past two years, the Bank of England has been selling government bonds back into the market, reversing the various rounds of quantitative easing undertaken since 2008. The money it receives for these gilts is then destroyed, reducing the level of reserves in the system.
In a recent speech, Andrew Bailey, the Bank of England’s Governor, said more banks were turning to the facility as the cost of liquidity in money markets rose relative to Bank Rate, which currently stands at 5.25 per cent.
“This is encouraging,” he said in a speech last week. “The Bank is open for business and our facilities should be used as a way for counterparties to access reserves as necessary.”
Dave Ramsden, deputy governor for markets and banking, agreed that the facility was working “exactly as intended…The repo market has been functioning well over the last few weeks“.
Bailey noted that the facility illustrates the “benefits of having tried and tested liquidity facilities” as banks approach their preferred levels of bank reserves.
The preferred minimum level of reserves is the level at which there are sufficient reserves in the system to ensure banks can settle everyday transactions and hold cash against potential outflows in times of stress.
The latest estimates for banks’ preferred level is somewhere between £345bn and £490bn. Some analysts have questioned whether surging demand for the short-term lending facility indicates that the system is nearing this range.
“The level of take-up in the short-term repo facility offers some indication of when the BoE might be close to the biting point, where reserve supply meets reserve demand,” analysts at Natwest said.
However, Bank of England officials have stressed that a lot of recent demand for the facility reflects short term factors, including currency movements and large gilt syndications.