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Quarterly Bulletin 2011 Q3 | Volume 51 No Quarterly Bulletin 2011 Q3 | Volume 51 No. 3 Quarterly Bulletin 2011 Q3 | Volume 51 No. 3 Foreword The Bank of England has two core purposes: to maintain monetary stability and to maintain financial stability. Monetary stability means stable prices — as defined by the Government’s inflation target — and confidence in the domestic currency. Financial stability entails detecting and reducing threats to the financial system as a whole. This edition of the Quarterly Bulletin presents a number of articles pertinent to these two core purposes. The Bulletin begins, as usual, by examining developments in financial markets. The Markets and operations article reviews developments in financial markets covering the period between the previous Bulletin and 26 August 2011. Conditions in financial markets deteriorated markedly over the review period. Uncertainty increased as worries about the prospects for fiscal policy — both in the euro area and the United States — interacted with concerns about the sustainability of the global economic recovery to cause a worsening in financial market sentiment. Investors responded by seeking refuge in assets that they perceived to be less risky. Expectations for interest rate increases were pared back across the major economies and equity prices fell sharply, particularly for financial companies. Primary capital markets experienced relatively low levels of activity, with little term issuance in public markets by UK banks. The second article reviews the evidence for the impact of the Bank of England’s programme of asset purchases — often called ‘quantitative easing’ — both on financial markets and more widely on the economy. Between March 2009 and January 2010, the Bank of England purchased £200 billion of assets with the aim of injecting money into the economy to boost nominal spending and inflation in order to meet the inflation target in the medium term. The evidence presented in the article suggests that the effects were economically significant. Drawing on a range of different approaches the analysis suggests a peak effect on the level of real GDP of between 1½% and 2% and a peak effect on annual CPI inflation of between ¾ and 1½ percentage points. Further analysis suggests that these asset purchases may have had roughly an equivalent impact on inflation as a cut in Bank Rate of between 150 to 300 basis points. But there is considerable uncertainty around these estimates and the precise impact of asset purchases or sales is likely to vary depending on the circumstances in which they are conducted. The Monetary Policy Committee will continue to monitor and assess the impact of its asset purchases to date, in order to inform any future decisions on either selling the assets back, or making further purchases. The United Kingdom’s Special Resolution Regime (SRR) was born out of the difficulties in dealing with the failure of Northern Rock in the autumn of 2007. A bank resolution regime will typically give the resolution authority powers to split the bank into separate parts, transferring to a purchaser those creditors and economic functions that are of systemic importance while leaving the rest to be wound up in insolvency. The article in this edition provides a general overview of the principal objectives and features of a bank resolution regime, drawing in particular on the design of the United Kingdom’s SRR. It then discusses the safeguards put in place to help protect those creditors left behind and discusses the exceptions to those safeguards. Securities lending plays an important role in supporting market liquidity and helping markets operate smoothly and efficiently. But by increasing the interconnections between institutions such lending can pose potential risks to financial stability, which can be exacerbated by a lack of transparency in the securities lending market. The article in this edition provides an overview of securities lending and discusses the benefits and potential risks to financial stability. It goes on to discuss recent developments in securities lending, including the impact of regulation on the market and the potential introduction of new market infrastructure, such as central counterparties. The Bank of England will continue to monitor closely developments in the securities lending market given its importance to financial stability. In the decade before the financial crisis, measured growth in UK financial services output was twice that of overall UK GDP. But care must be taken when interpreting these data. Although data on financial services output are produced in accordance with international best practice, estimating financial services output accurately throws up a number of conceptual and practical challenges. The article in this edition explains some of the challenges associated with measuring financial services output and assesses the uncertainty around estimates in the decade leading up to the financial crisis. The analysis suggests that financial services output was probably overstated somewhat in the decade before the crisis, although this is likely to have had only a small impact on the growth rate of overall GDP. A further article in this edition presents the results of a new biannual survey of the sterling money market, launched in May of this year. The survey was conducted on behalf of the Money Market Liaison Group and is intended to supplement the Bank’s long-standing gathering of market intelligence in this market. Over time, the survey is expected to help identify structural trends in the sterling money market, aiding policymakers’ assessment of the impact of their actions on the behaviour of market participants. Some of the key results from the inaugural survey showed that in May 2011 reported activity in the sterling money market was greater in the secured market than the unsecured market, and that daily activity was concentrated at short maturities. Banks were, in aggregate, reported to be net borrowers from the non-bank sector in the market. Survey respondents also perceived the secured market was functioning better than the unsecured market. This edition also contains a summary of the main points made by participants at the most recent Monetary Policy Roundtable, hosted by the Bank of England and the Centre for Economic Policy Research, on 24 June. Spencer Dale Chief Economist and Executive Director — Monetary Analysis and Statistics. Research work published by the Bank is intended to contribute to debate, and does not necessarily reflect the views of the Bank or of MPC members. Contents Recent economic and financial developments Markets and operations 184 Box Operations within the sterling monetary framework and other market operations 188 Box Asset purchases 192 Box The Bank of England’s foreign exchange reserves 194 Research and analysis The United Kingdom’s quantitative easing policy: design, operation and impact 200 Bank resolution and safeguarding the creditors left behind 213 Box Bank resolution and the protection of property rights 216 Box The potential effect of transfer powers on creditors left in the insolvent bank 217 Box Creditor safeguards that restrict the use of transfer powers 219 Box Measures which could ease the practical pressures of complying with safeguards 222 Developments in the global securities lending market 224 Box Reinvestment of cash collateral from securities lending 228 Box Collateral swaps 231 Measuring financial sector output and its contribution to UK GDP 234 Box The composition of the financial services sector 237 Box The measurement of output in the banking sector 240 Box Intermediate and final demand 243 The Money Market Liaison Group Sterling Money Market Survey 247 Box Existing data sources 249 Summaries of recent Bank of England working papers 253 – An estimated DSGE model of energy, costs and inflation in the United Kingdom 253 – The impact of permanent energy price shocks on the UK economy 254 – Evolving UK and US macroeconomic dynamics through the lens of a model of deterministic structural change 255 – Preferred-habitat investors and the US term structure of real rates 256 Report Monetary Policy Roundtable 258 Speeches Bank of England speeches 262 Appendices Contents of recent Quarterly Bulletins 268 Bank of England publications 270 The contents page, with links to the articles in PDF, is available at www.bankofengland.co.uk/publications/quarterlybulletin/index.htm Author of articles can be contacted at [email protected] The speeches contained in the Bulletin can be found at www.bankofengland.co.uk/publications/speeches/index.htm Except where otherwise stated, the source of the data used in charts and tables is the Bank of England or the Office for National Statistics (ONS). All data, apart from financial markets data, are seasonally adjusted. Quarterly Bulletin Recent economic and financial developments 183 Recent economic and financial developments 184 Quarterly Bulletin 2011 Q3 Markets and operations This article reviews developments in sterling financial markets, including the Bank’s official operations, between the 2011 Q2 Quarterly Bulletin and 26 August 2011.(1) The article also summarises market intelligence on selected topical issues relating to market functioning. Sterling financial markets Chart 1 Gold price and Swiss franc effective exchange rate index (ERI) Indices: 4 January 2011 = 100 Overview 140 Financial market sentiment deteriorated markedly over the review period. Volatility increased across a range of markets, Gold 130 as investors tried to reduce their exposure to risky assets and Previous Bulletin sought refuge in so-called ‘safe haven’ assets. Contacts noted (a) that the functioning of some markets had, at times, become 120 impaired. 110 Swiss franc Fiscal developments continued to be a key influence on ERI financial markets. Existing concerns about the sustainability of 100 fiscal positions and the implications for banking sectors spread to some euro-area economies that had previously been less 90 Jan. Feb. Mar. Apr. May June July Aug. affected. Spreads between the yields of sovereign bonds of 2011 several euro-area countries and those of German government Sources: Bloomberg and Bank calculations. bonds remained elevated, and in some cases rose further.
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