QE & gilt yields

Guido has asked a good question: aren’t gilt yields being held down by quantitative easing, in which case they’ll rise when this policy stops?
I suspect, however, that the impact of QE is small.
One way I reached this view was by asking: what would yields be in the absence of QE? A few days ago, in my day job, I estimated that past relationships with equity volatility, Libor and US Treasuries meant that gilt yields should have been around 4%. At the time they were 3.8% - though they’ve since risen.
Alternatively, we can compare the yields on gilts directly affected by QE to those not directly affected. When it began QE, the Bank said (pdf) it would buy gilts of less than 25 years’ maturity. We can therefore get an idea of the impact of QE by comparing the 2032 gilt - a 23 year maturity - to the 2036 one, a 27-year stock which the Bank doesn't buy.
Between March 4 (just before QE was announced) and March 13 (the low point for the 2032 yield), the yield on the 2032 gilt fell 92 basis points, whilst the 2036 yield fell 64 basis points. This suggests a QE effect of 28 basis points.
Since March 4, the 2032 yield has fallen 8bps, whilst the 2036 yield has risen 12 bps. This suggests a QE effect of 20bps.
All this points in the same way. QE has had a small effect in depressing yields - less than 30bps.
There’s a simple reason why the effect should be small. Yes, Bank buying should reduce yields directly. But if QE works as the Bank hopes, it should raise yields. This is because the Bank hopes to increase economic growth and inflation by “printing money”, which is bad for gilts. In this sense, the fact that QE has slightly reduced yields is a sign of market scepticism about the efficacy of QE.
So, I suspect the ending of QE shouldn’t raise yields much.
This doesn’t, though, mean I’m bullish of gilts. I suspect global economic recovery, and the inflation this’ll generate will add more to yields  - and if the UK leads the recovery, yields here might rise more. And in the long-term, I suspect the decline of Asia’s savings glut and fears about the US fiscal position could return real yields to more normal levels.
QE, though, is a secondary matter.

Comments

[[email protected]]

Will quantitative easing stop soon? There seems no sign of it.

[John]

"We can therefore get an idea of the impact of QE by comparing the 2032 gilt - a 23 year maturity - to the 2036 one, a 27-year stock which the Bank doesn't buy."

No we can't! If you make the 23-year less attractively priced by pumping in a load of printed money, you make the 27-year more attractive to existing purchasers on a relative basis, therefore driving up the price of that, and the yield down as well.

Returning to my housing market analogy, supposing that instead of buying 200,000 houses a month and seeing what happens to the price, as in my previous though experiment, I instead buy 100,000 flats.

Do you think the purchase of 100,000 flats a month would do nothing to the price of small houses? Of course it would - people I had crowded out of the flat-buying market would increase the demand for other suitable properties.

[chris]

John - you're right: hence the use of my word "directly". The question is how big is that secondary effect?
You could simply ignore what happened to the 2036 stock, and take the 92bp fall in the 2032 yield as an estimate of the QE effect. But that runs into the problems:
1. Yields around the world were falling then.
2. This effect includes scepticism about whether QE would raise inflation and activity, which has waned a little since then.
Offsettingly:
3. Yields might have been low before March 5, as the market anticipated QE.
I don't see how QE can have had a large effect (moe than 100bp) on yields.

[Matthew]

"This is because the Bank hopes to increase economic growth and inflation by “printing money”, which is bad for gilts."

So the (imperfect) analogy would be the BoE buying a 1/10th of the housing stock by building another 3m houses?

[JimH]

Surely the whole point regarding QE and gilt yields is that QE should have driven prices up (and yields down), but in fact, after initially doing so, has failed to stop yields rising back to close to where we started?

Which implies the BoE is the only buyer in town, and everyone else is a seller? Thus depressing prices, and raising yields. Given the amount of debt to be sold in the next three years, unless the BoE buys the lot, a buyers strike seems inevitable.

Crucially, too, what will happen when (if?) QE is reversed? If the BoE buying all these gilts can't drive prices up, guess what it'll be like when they try to offload them into the market.

[Mark Wadsworth]

Logic says QE doesn't have much effect on anything at all, because it's just two branches of government (DMO and BoE) shuffling bits of paper between themselves.

That said, the jump in gilt prices on the day they announced it was quite staggering, around five points, and even more so in the USA, about eight points. But as somebody has already said above, yields are now above where they were (and prices are now below where they were).

The increase in money supply only happens if the BoE overpays for gilts, which they are probably doing, but only by a per cent or two, so of all that promised £150 billion, only two per cent of that has 'increased money supply'.

[guthrie]

Surely the only reason to use QE is that it increases the amount of money in circulation without creating debt at the same time?

[Mark Wadsworth]

@ guthrie, money IS debt. Even a humble banknote or coin is a non-interest bearing government security.

Whether the government 'borrows' money from the general public by issuing gilts or just prints loads of new notes and dishes them out on street corners, the effect is to increase (nominal) government debt

[guthrie]

But there's still effectively more money in circulation without habving a debt which has to be paid back marked against someone. I don't see gvt debt levels rising because of this. Compared to borrowing money which increases the amount going round but also with debt, and oddly enough we seem to have even more debt than there is money.

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[cjcjc]

Erm, aren't the levels of Libor and UST's also (possibly) artificially low?
If so then gilt yields are in the same position.
The fact that gilts are not out of line with these may simply reflect that the whole structure of global rates is being held down by central banks. For now...

[rolex day date]

And a lot of it reflects a switch from bank deposits to securities; foreigners “other investments” in the UK, http://www.watchgy.com/ mostly bank deposits, fell by £143.2bn in Q1. And of course there’s no guarantee such buying will continue.
http://www.watchgy.com/tag-heuer-c-24.html
http://www.watchgy.com/rolex-submariner-c-8.html