Minutes of the Productive Finance Working Group – 15 March 2022

Agenda

1. Competition law reminder by Simmons & Simmons LLP

2. Updates from the sub-groups and discussion

3. Updates from the official sector

Minutes

Item 1 – Competition law reminder by Simmons & Simmons LLP

Simmons & Simmons LLP set out the legal obligations of all members of the Working Group relating to competition law.footnote [1] They reminded members that it is their responsibility to meet their legal obligations and to take their own legal advice.

Item 2 – Updates from the sub-groups and discussion

The chairs of the Technical Expert Group (TEG) footnote [2] welcomed the meeting participants and set the aims of the meeting – to discuss progress made by the sub-groups ahead of the Steering Committee meeting on 30 March 2022. These sub-groups cover five workstreams, focusing on value for money, actions by investment and employee-benefit consultants, performance fees, liquidity management, and raising awareness.footnote [3] The leads from each sub-group provided short summaries of progress for discussion, as follows.

Value for money: In the case of less liquid assets in the DC schemes’ default arrangements, the key challenge to shifting the focus from cost to value is the tension between the certainty of cost and uncertainty of future returns, making many focus primarily on keeping costs low. Less liquid assets tend to be more expensive and may take some time to generate value, and some of them may fail to do so. A key challenge for Trustees and other decision makers is how to ensure they act in the interests of members, while facing this tension between the certainty of cost and uncertainty of future return. Trustees, employers and other investment decision makers need transparent, robust and consistent value metrics. The proposed FCA-TPR Value for Money (VFM) framework, which is also consistent with DWP’s focus on value, can help to facilitate this. To support implementation of this framework, the sub-group is working on a guide, focusing on assessing value from less liquid assets specifically.

Investment and employee-benefit consultants: The Group is developing a proposal for investment and employee-benefit consultants to jointly make a public commitment to such a shift in their discussions with and advice to clients. The Group is also exploring how Trustees & employers could support this shift, e.g., by considering less liquid assets as part of the strategic asset allocation reviews, communicating with the members on the basis of value, challenging their consultants and providers, and exploring the synergies with the net zero transition and ESG agendas that have an inherently long-term focus.

Liquidity management: A guide will explore key liquidity management considerations from the perspective of DC decision makers, considering or already investing in less liquid assets. The guide will consider the impact of liquidity at three levels: the DC scheme member level, the strategy level (DC scheme wrapper), and the level of a fund that invests in less liquid assets.

Fees and T&C: The sub-group is working on a guide for Trustees / employers on performance fees, setting out what they are and the key considerations. There is a broad range of views on performance fees. The aim is not to sponsor or advocate the use of performance fees, but to move the debate forward by setting out potential approaches to adapting performance fees from a DC scheme’s perspective – to ensure they deliver value for money and fairness across cohorts of DC scheme members and overcome the operational challenges specific to DC schemes. The sub-group is also producing a guide on LTAF legal considerations and model LTAF constitutional documents, aimed at increasing understanding of LTAF as a new fund structure.

Raising awareness: this workstream aims at raising awareness of the key considerations around investment in less liquid assets among a broad range of market participants, by bringing together the outputs produced by the other TEG sub-groups. This workstream is working on a communications and rollout startegy, coordinated among the trade bodies and covering a range of formats including events and conferences, published materials, webinars, training sessions and teach-ins.

Discussion: TEG members were broadly supportive of the work of the sub-groups and thought it was important to ensure that these outputs have a tangible and lasting impact. It was noted that further thought is needed as to how best to package and present the materials produced by the TEG, to maximise their impact. There was also some discussion on whether it is helpful to sequence working through the barriers, and there was a broad agreement that it is important to work on all the barriers in parallel, given it is a multi-faceted issue and all stakeholders needed to play their part and there was a need to break away from a tendency to consider supply and demand separately. The tone of the documents would need to be carefully calibrated too, so that issues for consideration are presented in a neutral and objective way – road testing the material would be key to this.

Item 3 – Updates from the official sector

FCA presented on its work to review the classification of LTAFs as non-mainstream pooled investments and the possibility of appropriately managed distribution of LTAFs to retail clients and is planning to consult on this later in 2022. This will be done in a broader context of the recent HMT and FCA consultations on changes to the financial promotions regime and the classification of high-risk investments. The FCA is also taking forward the PFWG recommendation on permitted links.

FCA and TPR presented on their work on a value for money framework for all defined contribution FCA and TPR-regulated pension schemes, with an aim to support a shift in focus from cost to value. Once published, this framework could help reach the required common understanding of value by developing metrics and enabling comparisons of value between pension schemes. A joint feedback statement on the recent FCA / TPR discussion paper is expected later this year, to be followed by FCA / DWP consultations on a proposed framework. This is a complex, cross-industry piece of work which may require a phased approach.

DWP summarised their proposals, recently consulted on, to remove well-designed performance-based fees from the regulatory charge cap and provide appropriate accompanying mechanisms to ensure member interests remain protected. DWP has also continued its work on DC scheme consolidation and came to a view that the ongoing FCA / TPR work on value for money could be a more effective way forward to support consolidation. Government will soon be publishing a response to the recent charge cap consultation and the earlier call for evidence on DC scheme consolidation. More broadly, DWP will continue its support for enabling increased investment in less liquid assets and for removing the barriers to it.

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Statistical Notice 2022/17 | Bank of England

Publication of Form IPA Public Working Draft (PWD) (Statistical Forms Taxonomy 1.3.0)

On Monday 15 August the Bank’s Data and Statistics Division published version 1.3.0 public working draft (PWD) of the Bank of England Statistics taxonomy, which has been updated to include the longstanding Excel based collection, Form IPA. 

As per Green Notice 2022/01, this migration continues the process of building consistency in data submissions across the population of statistical forms and follows consultation with reporting Issuing and Paying Agents regarding the new format, requirements and reporting technology.
The taxonomy, data point model (DPM) dictionary, annotated templates and validation rules represent the reporting requirements outlined in the Form IPA definitions accompanying the release, available on the new and upcoming forms of the Bank of England website. The data point model is an extension of the European Banking Authority’s (EBA) data point model and filings will be subject to the EBA filing rules as published on the reporting frameworks.

We invite feedback, particularly from firms and software vendors, on the PWD technical artefacts to uktaxonomypwdfeedback@bankofengland.co.uk by Friday 9 September 2022. This PWD should not be used for reporting. We will aim to publish the final version of the taxonomy and DPM in mid-October at which point we will indicate the date of first reporting via Statistical Notice.

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Minutes of Bank of England call with GEMMs on its provisional approach to APF gilt sales – 5 August 2022

Minutes

Introduction

Bank staff provided an overview of the information published in the provisional Market Notice relating to APF gilt sales on 4 August 2022.

In the minutes of its meeting ending on 3 August 2022, the MPC had said that it was provisionally minded to commence gilt sales shortly after its September policy meeting, subject to economic and market conditions being judged appropriate and subject to a confirmatory vote at that meeting. The Monetary Policy Committee (MPC) had asked the Bank to be in a position to begin a sales programme before the end of September. The accompanying provisional Market Notice set out the key features of how the Bank would achieve a reduction in the stock of gilts held in the APF over a twelve-month period, if voted for by the MPC.

Attendees were reminded of their responsibilities under competition law in relation to this discussion.

Questions from attendees

Discussion in the meeting covered the following questions.

1: How will the Bank choose the amount to be sold each quarter?

The amount of APF stock reduction will be set by the MPC over a twelve-month period and expressed in terms of the initial proceeds paid to purchase the APF holdings. This is consistent with the terms in which the stock of APF holdings has been measured since its inception, and the approach taken to gilt maturities to date.

The MPC judged that, over the first twelve months of a sales programme starting in September 2022, a reduction in the stock of purchased gilts held in the APF of around £80 billion was likely to be appropriate.

Gilt redemptions over this period will reduce the stock of holdings in the APF by £35 billion in initial proceeds terms. The Bank’s sales programme would therefore be calibrated to achieve a further reduction in the stock of £45 billion in initial proceeds terms.

The precise amount of sales required to achieve this will depend on the price realised on those sales relative to the average price at which the relevant gilts were initially purchased by the APF. This cannot be predicted perfectly in advance, but can be estimated based on prevailing market prices and assuming a broadly even distribution of sales across the gilts in each bucket. On that basis the size of the sales programme necessary is expected to be around £40 billion over the twelve months, or £10 billion per quarter.

To account for these dynamics, the Bank will set a specific sales schedule once per quarter, accounting for prevailing market prices, the realised distribution of sales across the APF’s holdings in previous quarters, and the available operating dates in the quarter ahead.

2: Will the announced pace be equally split across months or could there be more in a month/fortnight?

The quarterly schedule of operations, setting out the precise timing and size of gilt sale operations, will be announced by the Bank around two weeks ahead of the end of each calendar quarter.

The Bank’s intention is to spread sales as evenly as possible across the quarter, and with equal sizes across operations. As with all aspects of the sale programme, the Bank will keep this under review.

3: Is there a set number of APF gilt sale operations a quarter that the Bank will run? Will the Bank be operating every week?

The Bank’s operation schedule will be set quarterly, and announced around two weeks before the start of each calendar quarter. The number of operations per quarter will depend on the operating days available and could vary depending on a number of factors, including UK public holidays and DMO issuance plans.

Subject to those restrictions, the Bank will usually aim to hold an auction in each maturity sector once per fortnight. Where possible the Bank will hold short and medium maturity bucket auctions in the same week and long bucket operations in the following week as a way to balance the supply of duration into the market. 

4: What would be the implications of an uncovered or cancelled auction in terms of completing the quarter’s sales?

The Bank’s approach will remain consistent with that taken during purchase operations. Any cancelled auctions may be rescheduled within the quarter, where appropriate and any shortfall in sales completed during a quarter overall will be accounted for in the following quarterly sales schedule.

5: How will the Bank decide whether to adjust the sales programme in response to any a deterioration in market conditions?

In terms of the overall programme, the MPC has said there would be a high bar for amending the planned reduction in the stock of purchased gilts outside the scheduled annual review. If such amendments were judged necessary, for example if markets were judged to be very distressed, the MPC said it would first consider amending or halting the sales programme before considering restarting reinvestments or additional asset purchases.

At an operational level, the Bank will closely monitor the impact of its APF gilt sales programme on market conditions, and reserves the right to amend its schedule (including the gilts to be sold), pricing method or any other aspect of its approach at its sole discretion. For example, during APF gilt purchases, a small number of auctions were cancelled due to technical reasons with the shortfall in purchases made up at a later date in order to meet the MPC’s target.

6: Did the Bank consider aligning its maturity buckets in line with the DMO, specifically for long maturity operations to be 15 years+?

The maturity bucket definitions for gilt sales are in line with APF purchase operations since March 2020 and allow for a broadly even distribution of sales across the APF portfolio. As with all parameters the Bank will keep its bucket definitions under review.

7: Would the Bank consider allocating a higher proportion of the APF sale operations to shorter maturities, for example in response to strong auction results in that sector?

The Bank has designed APF gilt sale operations in a way that makes all gilts available for sale and in a manner that allows for a consistent approach over time, for as long as the MPC vote to reduce the APF stock of gilt holdings. Selling a greater proportion of ‘short’ maturity holdings at the start of the programme would leave the APF portfolio less balanced and imply a greater proportion of ‘long’ maturity sales later, and vice versa.

8: Did the Bank consider restricting its sales to bonds where it has large holdings? For example only making gilts eligible for sale if the APF holds more than 35% of the free-float.

The Bank has designed APF gilt sale operations in a way that makes all gilts available for sale in order to remain market neutral and respond to demand in the auctions. This will also allow for a consistent approach over time, for as long as the MPC vote to reduce the APF stock of gilt holdings. The Bank will continue to monitor gilt market functioning, and the impact of APF operations over the course of its sale programme.

9: What is an acceptable range of prices to bid within the auctions?

The Bank reserves the right to set a private limit (or ‘reserve’ price) on the yield it is willing to accept in gilt operations. This is similar to APF purchase operations to date and the market can assume that is the case moving forward. Market participations should make their own judgements on the price they are willing to bid in the Bank’s auctions. The Bank will continue to publish detailed results for each operation to provide post-trade price transparency.

10: How will auctions be allocated and priced?

Consistent with the approach taken in APF gilt purchase operations, bids on different stocks in APF gilt sale operations will be allocated using a discriminatory pricing method based on their attractiveness relative to market mid yields. This provides a simple, transparent and well understood process, based on clearly observable pricing benchmarks.

11: The Bank has said it will require GEMMs to identify any bids submitted on behalf of a client using unique identifiers. Will clients be able to submit bids, if they do not yet have this code?

Information on the interaction of the Bank’s operations with the broader market is central to understanding the impact of the Bank’s monetary and financial stability policies. From the start of APF gilt sales, the Bank will therefore require participants in its APF gilt operations to identify any bids or offers submitted on behalf of a client, and disclose the names of underlying clients via a set of unique client identifiers to be determined by the Bank.

The Bank encouraged GEMMs to help clients set up codes well in advance of any potential start date of APF sale operations. But in the rare instance in which a participant code has not been set up in advance of the operation, the Bank will provide a means for new participants to take part in auctions via GEMMs prior to an identifier code being assigned.

Further provisional detail on operational terms and how to participate will be published on or around 1 September 2022.

12: What time of day do you expect these operations take place?

Further detail on operational parameters will be published on or around 1 September 2022.

APF purchase operations to date have taken place in the afternoon, to minimise overlap with the DMO’s operations which have typically taken place in the morning. Since APF sale operations will usually be held on Mondays and Thursdays, this may be less relevant in future. The Bank therefore invited views from participants on their preferred approach to inform its decision.

13: Will the Bank be publishing the collateral it receives via the Short Term Repo Facility?

No. The Bank does not provide details of the collateral positioned by participants in any of its lending operations.

Attendees

Banco Santander

Barclays

BNP Paribas

Citigroup Global Markets

Deutsche Bank

Goldman Sachs

HSBC Bank PLC

JP Morgan

Lloyds Bank Corporate Markets plc

Merrill Lynch

Morgan Stanley & Co International plc

NatWest Markets

Nomura

Royal Bank of Canada

UBS

Bank of England

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Minutes of the CBDC Engagement Forum – July 2022

Minutes

Date: 1 July 2022

Item 1: Welcome

Co-chairs Gwyneth Nurse and Jon Cunliffe welcomed Members to the fourth meeting of the CBDC Engagement Forum.

Item 2: Debrief of the last Technology Forum

The Bank of England provided a brief summary of the June Technology Forum meeting

Item 3: CBDC Payment Interface Providers business models

A Member of the Forum presented on potential business models for Payment Interface Providers (PIPs) in a CBDC ecosystem. The presentation set out that PIPs would likely undertake activities suggested in the Bank’s 2020 Discussion Paper on CBDC such as onboarding clients, conducting KYC (Know Your Costumer) and AML (Anti Money Laundering) checks, authenticating users and providing consumer protection and overlay services, among others. The presentation then laid out a set of costs that such a PIP would likely incur in offering those services.

The presenter assumed that PIPs would not be able to lend CBDC, nor use it as a source of funding, so a banking-like model based on revenues from net interest rate margin would not be possible. One Member suggested that it was important to define what non-financial corporate would be able to do with their CBDC holdings in contrast to what is possible currently with commercial bank money balances, as this could need to be factored into a revenue model calculation.

A fee-based business model for PIPs where end users are charged for the wallet service was deemed undesirable given current fee-free payment alternatives. It was argued, however, that customers could be willing to pay for a service if it provided increased functionality (e.g. programmability) or if its costs were lower than existing options where customers currently pay for specific services (e.g. cross-border payments).

The presenter suggested that a model where merchants would pay a fee for accepting payment in CBDC was more likely to be viable for PIPs, but adoption could depend on the costs of setting up the required infrastructure. It was argued that any limits on CBDC holdings or on transactions could influence how much customers used CBDC for day-to-day spending, which could in turn have an impact on how much revenue this model could generate.

The presentation also suggested that data monetisation and cross-selling opportunities were alternative means for PIPs to generate revenue. Some Forum Members thought that finding convincing business models for CBDC was not easy, while others argued that, similar to Open Banking, opportunities may be difficult to see at present but would be realised in the future. One Member argued that payment providers would consider the whole transaction lifecycle when identifying revenue opportunities for a new payment method, not only the payment element itself. This would include considerations such as the ‘halo effect’, the value to merchants of generating brand loyalty by accepting a specific payment method that costumers prefer. It was also noted that merchants and payment service providers had already incurred costs of building an infrastructure and onboarding customers that they would look to leverage to the extent possible for any new payment product, which would also influence the revenue-cost calculation.

One Member suggested that there were public policy considerations that would need to be factored into the cost calculation, as authorities may want to incentivise the use of CBDC to meet certain public policy goals, such as improving financial inclusion.

Item 4: Key G7 Public Policy Principles for retail CBDCs to support decision makers

A second Member presented a view on how the private sector could collaborate with policymakers to deliver on some of the G7 Principles on CBDC (published in October 2021). The presenter suggested four principles where the private sector relevant experience would be useful for the Bank and HMT when designing a CBDC. These principles were (i) operational resilience and cyber security, (ii) competition, (iii) illicit finance and (iv) data privacy.

The presenter noted that it was imperative to ensure operational resilience and cyber security in the CBDC payment chain end-to-end in order to build trust. Given the payment chain would involve different players, the central bank would have to create clear rules and standards of participation to require resilience and security along the chain. Central banks would also need to ensure CBDC capabilities are ‘secure by design’ and forward looking as much as possible, to tackle new threats such as quantum computing. Non-technical resilience elements were noted as integral too, such as behavioural rules and consumer protections.

On competition, the presenter spoke about the importance of interoperability of CBDC with existing payments systems to ensure user choice and support the level playing field. It was argued that leveraging existing infrastructure for on and off ramps into and out of CBDC was desirable to alleviate costs, especially for merchants.

With regards to illicit finance and data protection the presenter noted that the two principles were closely linked in payments, due to the importance of capturing and processing certain bits of data to combat illicit activities. It was noted that CBDC would need to find a balance in order to be an accessible, fast and cheap payment system while maintaining a commitment to mitigate its use for criminal activity.

In response to the presentation, one Member argued that all layers of the CBDC system had to be assessed separately to understand what is most important to deliver when building it. This would mean laying out the fundamental elements of each layer (the core infrastructure layer, the PIP layer, and so on) and determining which elements belong in each layer (ledger provision, operational resilience, ID validation etc.).

Closing remarks

The co-Chairs closed the meeting and thanked the Members for their contributions.

Attendees

Jon Cunliffe (Chair) Bank of England
Gwyneth Nurse (Chair) HM Treasury
Tom Mutton, Bank of England
Danny Russell, Bank of England

Members

Adam Jackson, Director of Policy, Innovate Finance
Bryan Zhang, Executive Director, Cambridge Centre for Alternative Finance, the University of Cambridge Judge Business School
Chris Wilford, Director of Financial Services Policy, CBI
Jana Mackintosh, Managing Director Payments & Innovation, UK Finance
Jess Houlgrave, Chief of Staff, Checkout.com
Martin McTague, National Policy Chair, Federation of Small Businesses
Matthew Hunt, Chief Strategy Officer, Deputy CEO, PayUK
Natasha de Terán, Member of the Financial Services Consumer Panel
Paul Bances, Head of Global Market Development of Blockchain, Cryptocurrency, and Digital Currencies, PayPal
Polly Tolley, Director of Impact, Citizens Advice Scotland
Ruth Wandhöfer, Chair, PSR Panel
Simon Gaysford, Founder & Director, Frontier Economics
Simon Gleeson, Financial Regulatory Group Lead, Clifford Chance
Stephen Gilderdale, Chief Product Officer, SWIFT
Tracey McDermott, Group Head of Conduct & Financial Crime, Standard Chartered Bank

Observers

Susannah Storey, Department for Digital, Culture, Media & Sport

Apologies

Andrew Murphy, Executive Director for Operations, John Lewis Partnership
Anne Boden, CEO, Starling Bank
Arun Kohli, COO EMEA, Morgan Stanley
Arunan Tharmarajah, Head of European Banking, Wise
Charlotte Hogg, CEO, Visa Europe
Christian Catalini, Chief Strategy Officer, Lightspark
Chris Rhodes, CFO, Nationwide Building Society
Diana Layfield, President of EMEA Partnerships, Google
Georges Elhedery, Co-CEO Global Banking & Markets, HSBC
Jorn Lambert, Chief Digital Officer, MasterCard
Judith Tyson, Research Fellow, Overseas Development Institute
Paul Thwaite, CEO Commercial Banking, NatWest Group
Reema Patel, Head of Deliberative Engagement, Ipsos UK
Simon Coles, CTO, PayPoint

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Change to the eligibility criteria for Short-term non-sterling liquidity facilities – Market Notice 8 August 2022

Market Notice

The Bank of England is today updating the eligibility criteria for access to its short-term non-sterling liquidity facilities, to better align eligibility with the Bank’s other lending tools. Currently only US Dollar Repo operations are active in this category.footnote [1]

Previously, non-sterling liquidity facilities were open to: a) any Operational Standing Facilities Participant (except CCPs and ICSDs); and b) any Open Market Operations (OMOs) participant whose Group contained an Operational Standing Facilities Participant.

With effect from 8 August 2022, only SMF members that are participants in OMOs (which includes participants in the Indexed Long-Term Repo operations) shall be eligible to participate in these short-term non-sterling liquidity facilities.

This change will not have any immediate impact on firms that can currently use these facilities. Participants whose access to short-term non-sterling liquidity facilities is affected by this change will be given a six-month grace period before their access is removed on 10 February 2023. If uninterrupted access to short-term non-sterling liquidity facilities is required, these participants should apply for access to the Open Market Operations within the six-month grace period. Otherwise, an application for access to Open Market Operations can be made at any point in the future.

Existing participants in Open Market Operations do not need to take any action in order to retain access to non-sterling liquidity facilities.

For queries on applying to participate in the Sterling Monetary Framework or Open Market Operations, contact the applications team via email applications@bankofengland.co.uk.

More information can be found within the Supplementary Terms for US Dollar Repo.

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Short Term Repo Facility – Provisional Market Notice 4 August 2022

Provisional Market Notice 

This provisional Market Notice should be read alongside the Explanatory Note setting out the Bank of England’s overall approach to managing the operational implications of APF unwind. 

A further Market Notice – containing full operational details of the Short Term Repo facility – will be published on or around 1 September alongside supporting and legal documentation. The launch of the facility will then be confirmed if and when the MPC votes to commence APF gilt sales.

Motivation for the facility

To ensure that short-term market interest rates remain close to Bank Rate as the level of sterling central bank reserves reduces, the Bank will launch a new short-term open market operation (OMO), the Short Term Repo (STR). This will commence at the same time as any APF gilt sales begin. The STR will sit alongside the Indexed Long Term Repo (ILTR) as an OMO under the Bank’s Sterling Monetary Framework (SMF).

The Bank intends that the STR should be used freely from the point of introduction, as a way for counterparties to access reserves as necessary. The PRA would judge use of the STR as routine participation in sterling money markets and intends that it should be seen as such by bank boards and overseas regulators.

Launch date and frequency of operations

The STR will be launched alongside the commencement of any APF gilt sales programme. Details of any APF gilt sales programme will be communicated separately. 

The Bank will conduct STR operations on a weekly basis, using the Bank’s electronic tendering system, Btender. STR operations will be held on Thursdays at 10:00am, except on MPC announcement days where the operation will be held at 12:30pm.

Subsequent to launch, and in line with the Bank’s usual approach, each STR operation will be confirmed via an announcement on the Bank’s wire services around one week in advance. 

Price

The STR will be priced at Bank Rate +0 bps and the rate will be indexed to Bank Rate.

Term

The STR will be a 7-day term-repo operation.

Size

The amount of reserves supplied in any STR operation will be unlimited.

Eligible Collateral 

Only collateral classed by the Bank as Level A will be eligible for use in STR operations. Participants are encouraged to deliver collateral securities to the Bank ahead of operations. Further information is available on the Eligible Collateral page.

Eligible institutions

The STR will be accessible by firms that are both SMF members and enrolled as OMO participants.

SMF members that wish to participate in the STR but which are not currently enrolled as OMO participants should complete the SMF application form available on the Information for applicants page and submit it by email to Applications@bankofengland.co.uk

The Bank will implement a routine test trade program for all OMO participants to ensure ongoing operational readiness. This will require participants to submit STR and ILTR trades periodically at the Bank’s request. Details will be communicated to relevant firms later in the year.

Other SMF facilities

The Bank will continue to offer liquidity insurance via its other facilities.

Because the STR will provide access to reserves against Level A collateral, at Bank Rate and in unlimited quantities for a 7-day tenor, the Bank intends to adjust the minimum spread for bids against Level A collateral for a 6-month tenor in the ILTR after STR operations commence. Further details will be published in due course.

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Explanatory Note: Managing the operational implications of APF unwind for asset sales, control of short-term market interest rates and balance sheet

Market notice

During the course of 2022, the Monetary Policy Committee (MPC) began reducing the stock of assets held in the Asset Purchase Facility (APF) to meet its monetary policy objective. On 3 February, the MPC voted to cease reinvestment of maturing gilts and corporate bonds, and asked Bank staff to design a programme to sell the APF’s holdings of corporate bonds to be completed no earlier than towards the end of 2023. At its May meeting, the MPC asked the Bank of England (the Bank) to develop a strategy for selling UK government bonds (gilts) held in the APF and committed to providing an update at its August meeting. Having reviewed that strategy, in August the MPC announced it was provisionally minded to commence gilt sales shortly after its September policy meeting, subject to economic and market conditions being judged appropriate and subject to a confirmatory vote at that meeting.

The monetary policy judgments underpinning these decisions are set out in the relevant MPC minutesfootnote [1] and Monetary Policy Reports.footnote [2] This Explanatory Note summarises the implications of the MPC’s decisions in three key areas: (1) the mechanics of APF asset sales; (2) ensuring short-term market interest rates remain close to Bank Rate, including via the prospective launch of a new Short-Term Repo facility; and (3) the longer-term asset composition of the Bank of England’s own balance sheet.

1: The mechanics of APF asset sales

The Bank has today published a Market Notice providing an overview of how it expects to implement APF gilt sales, which would be operationalised following a confirmatory vote by the MPC. It covers: the Bank’s approach to designing a gilt sales plan; liaison with the Debt Management Office (DMO); key operational terms; and details of additional information that the Bank will require Gilt-edged Market Makers to submit on end-client participation. Further detail will be published on or around 1 September, followed by confirmation of a specific auction schedule at the point of any MPC vote to commence gilt sales.

A high-level Market Notice relating to the sale of corporate bonds held in the APF was published in May of this year, and operational details of the Bank’s plan for sales will be set out in a further Market Notice to be published on 18 August (one month ahead of the start of sales in the week commencing 19 September).

2: Keeping short-term market interest rates close to Bank Rate: a new Short-Term Repo facility

The Bank’s balance sheet is used to implement the MPC’s decisions in order to meet the inflation target. Once the MPC makes a decision, Bank staff implement that policy. A core objective of the Bank’s approach to implementing monetary policy is to keep short-term market interest rates close to Bank Rate.

The Bank transmits Bank Rate to short-term market interest rates via the remuneration and supply of central bank liabilities (known as ‘reserves’) held by commercial banks. Reserves are remunerated at Bank Rate. They can be supplied in a variety of ways, but funding asset purchases by the APF has been by far the dominant source of reserves creation in recent years. This has left the stock of reserves well above the level required by commercial banks to meet their payments obligations and broader liquidity needs. The ample supply of reserves has ensured that commercial banks have had little need to bid up money market rates above Bank Rate to borrow reserves. At the same time, remuneration of reserves at Bank Rate has meant that banks have had no incentive to lend excess reserves at rates below Bank Rate. Taken together, this so-called ‘floor system’ has kept short-term interest rates very close to Bank Rate.

A reduction in the size of the APF has implications for the operation of this system. As assets held in the APF mature, or are sold back to the market, the reserves used to fund those purchases will be extinguished. Indeed, reserves have already fallen by £30bn to around £950bn since 4 February 2022, as assets held in the APF have matured. Reserves may also fall for other reasons, most notably via the repayment of loans made under the Bank’s Term Funding Scheme with additional incentives for small medium-sized enterprises (TFSME).

While reserves remain in ample supply relative to the needs of commercial banks, the floor system will continue to operate smoothly. But as APF unwind continues, the stock of reserves will eventually approach the minimum level needed by banks. At that point, banks are likely to respond by seeking to borrow reserves in money markets, increasing the rates they are willing to pay to do so and thereby causing short-term interest rates to rise relative to Bank Rate. If no other actions are taken, this would impair the transmission of monetary policy to the wider economy (see Chart 1).

Chart 1: Relationship between market rates and Bank Rate as reserves decline

As Section 3 below explains, the point at which reserves become scarce in this way is probably several years away, given the MPC’s initial pace of APF unwind. But commercial banks’ overall demand for reserves is highly uncertain. It will evolve in response to financial and economic conditions, and may also be influenced by the distribution of reserves across the system, or other features of market structure. It is therefore possible that reserves scarcity could arise much sooner than expected.

To ensure that short-term market rates remain close to Bank Rate whenever that point is reached, the Bank will launch a new open market operation, the Short-Term Repo (STR), at the same time that APF gilt sales begin. The facility will allow counterparties to borrow unlimited amounts of reserves for 7 days, against high quality Level A collateral, at Bank Rate. A Market Notice has been published today describing the facility’s key terms.

The STR will allow the MPC to focus solely on monetary policy considerations in setting its strategy for APF unwind, without concern for the Bank’s ability to align short-term market interest rates close to Bank Rate. Without the STR, in order to maintain control of short-term market interest rates the MPC would have to reconsider APF unwind at the point that upwards pressure on market rates began to appear, whether or not that was optimal from a monetary policy perspective.

Chart 2 illustrates how this will work in practice. At the point that reserves reach the minimum desired level, banks will be able to meet their demand for reserves at Bank Rate through use of the STR. This will stabilise the quantity of reserves supplied to banks, while allowing the MPC to continue reducing the stock of assets held in the APF.

Chart 2. Stylised supply of reserves during the APF unwind

This framework will also allow the Bank to retain the flexibility to expand or contract its balance sheet as needed to achieve its statutory policy objectives, while maintaining control of short-term interest rates. By both supplying and remunerating reserves at Bank Rate, the framework will ensure that commercial banks have little need to pay up in money markets for reserves (since they can borrow additional reserves from the STR at Bank Rate) or to lend excess reserves below Bank Rate (since they can earn Bank Rate by holding reserves at the Bank).

The intention is for the STR to be a weekly facility. It will complement the Bank’s other reserve supply operations including the Indexed Long-Term Repo (ILTR), which supplies reserves for six-months at a price related to demand, against a much wider range of collateral types than is envisaged for the STR.

The Bank intends that the STR should be used freely from the point of introduction, as a way for counterparties to access reserves as necessary. The PRA would judge use of the STR as routine participation in sterling money markets and intends that it should be seen as such by bank boards and overseas regulators.

3: Evaluating the longer term asset composition of the Bank of England’s own balance sheet

Under this new framework, the eventual future steady state size of the Bank’s balance sheet will be determined not by the size of the APF but by commercial banks’ demand for reserves. The Bank’s latest estimate of the minimum level of reserves demanded by banks, based on periodic surveys of banks’ reserves management practices, is somewhat below half the current stock of £950bn. But, as noted in Section 2, that estimate is both highly uncertain, and likely to vary over time in response to financial and economic conditions.

As reserves scarcity approaches and usage of the STR becomes consistently material in scale, the Bank will need to reflect on the appropriate long-term mix of assets on its own balance sheet. In doing so, the Bank will need to consider the implications of different assets for its policy objectives, market functioning, commercial banks’ liquidity positions, operational feasibility, and risks to the public sector balance sheet. The relative merits of the options will require careful evaluation before a final decision can be made. The estimates of the minimum level of reserves demand described above, coupled with the MPC’s initial pace of APF sales, suggest that it is likely to be some years before this decision needs to be finalised. The Bank’s aim would however be to reach a preferred direction of travel, in close consultation with relevant stakeholders, well before that point is reached.

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Bank Rate increased to 1.75% – August 2022

Monetary Policy Summary, August 2022

The Bank of England’s Monetary Policy Committee (MPC) sets monetary policy to meet the 2% inflation target, and in a way that helps to sustain growth and employment. At its meeting ending on 3 August 2022, the MPC voted by a majority of 8-1 to increase Bank Rate by 0.5 percentage points, to 1.75%. One member preferred to increase Bank Rate by 0.25 percentage points, to 1.5%.

Inflationary pressures in the United Kingdom and the rest of Europe have intensified significantly since the May Monetary Policy Report and the MPC’s previous meeting. That largely reflects a near doubling in wholesale gas prices since May, owing to Russia’s restriction of gas supplies to Europe and the risk of further curbs. As this feeds through to retail energy prices, it will exacerbate the fall in real incomes for UK households and further increase UK CPI inflation in the near term. CPI inflation is expected to rise more than forecast in the May Report, from 9.4% in June to just over 13% in 2022 Q4, and to remain at very elevated levels throughout much of 2023, before falling to the 2% target two years ahead.

GDP growth in the United Kingdom is slowing. The latest rise in gas prices has led to another significant deterioration in the outlook for activity in the United Kingdom and the rest of Europe. The United Kingdom is now projected to enter recession from the fourth quarter of this year. Real household post-tax income is projected to fall sharply in 2022 and 2023, while consumption growth turns negative.

Domestic inflationary pressures are projected to remain strong over the first half of the forecast period. Firms generally report that they expect to increase their selling prices markedly, reflecting the sharp rises in their costs. The labour market has remained tight, with the unemployment rate at 3.8% in the three months to May and vacancies at historically high levels. As a result, and consistent with the latest Agents’ survey, underlying nominal wage growth is expected to be higher than in the May Report over the first half of the forecast period.

Inflationary pressures are nevertheless expected to dissipate over time. Global commodity prices are assumed to rise no further, and tradable goods price inflation is expected to fall back, the first signs of which may already be evident. Although the labour market may loosen only slowly in response to falling demand, unemployment is expected to rise from 2023. Domestic inflationary pressures are therefore expected to subside in the second half of the forecast period, as the increasing degree of economic slack and lower headline inflation reduce the pressure on wage growth. Monetary policy is also acting to ensure that longer-term inflation expectations are anchored at the 2% target.

The risks around the MPC’s projections from both external and domestic factors are exceptionally large at present. There is a range of plausible paths for the economy, which have CPI inflation and medium-term activity significantly higher or lower than in the baseline projections in the August Monetary Policy Report. As a result, in coming to its assessment of the outlook and its implications for monetary policy, the Committee is currently putting less weight on the implications of any single set of conditioning assumptions and projections.

The August Report contains several projections for GDP, unemployment and inflation: a baseline conditioned on the MPC’s current convention for wholesale energy prices to remain constant beyond the six-month point; an alternative projection in which energy prices follow their downward-sloping futures curves throughout the forecast period; and a scenario which explores the implications of greater persistence in domestic price setting than in the baseline. These are all conditioned on announced Government fiscal policies, including the Cost of Living Support package announced in May. There are significant differences between these projections in the latter half of the forecast period. However, all show very high near-term inflation, a fall in GDP over the next year and a marked decline in inflation thereafter.

The MPC’s remit is clear that the inflation target applies at all times, reflecting the primacy of price stability in the UK monetary policy framework. The framework recognises that there will be occasions when inflation will depart from the target as a result of shocks and disturbances. The economy has continued to be subject to a succession of very large shocks, which will inevitably lead to volatility in output. Monetary policy will ensure that, as the adjustment to these shocks occurs, CPI inflation will return to the 2% target sustainably in the medium term.

The labour market remains tight, and domestic cost and price pressures are elevated. There is a risk that a longer period of externally generated price inflation will lead to more enduring domestic price and wage pressures. In view of these considerations, the Committee voted to increase Bank Rate by 0.5 percentage points, to 1.75%, at this meeting.

The MPC will take the actions necessary to return inflation to the 2% target sustainably in the medium term, in line with its remit. Policy is not on a pre-set path. The Committee will, as always, consider and decide the appropriate level of Bank Rate at each meeting. The scale, pace and timing of any further changes in Bank Rate will reflect the Committee’s assessment of the economic outlook and inflationary pressures. The Committee will be particularly alert to indications of more persistent inflationary pressures, and will if necessary act forcefully in response.

In the minutes of its May 2022 meeting, the Committee asked Bank staff to work on a strategy for selling UK government bonds (gilts) held in the Asset Purchase Facility and committed to providing an update at its August meeting. Based on this analysis, the Committee is provisionally minded to commence gilt sales shortly after its September meeting, subject to economic and market conditions being judged appropriate and to a confirmatory vote at that meeting.

Minutes of the Monetary Policy Committee meeting ending on 3 August 2022

1: Before turning to its immediate policy decision, and against the backdrop of its latest economic projections, the Committee discussed: the international economy; monetary and financial conditions; demand and output; and supply, costs and prices. The Committee also discussed its strategy for selling UK government bonds held in the Asset Purchase Facility.

The international economy

2: UK-weighted global GDP growth was likely to have slowed in 2022 Q2, and was projected to remain weak in Q3. The latest rise in gas prices and, to a lesser extent, a tightening in financial conditions, had led to another significant deterioration in the outlook for global economic activity.

3: According to the preliminary flash estimate, euro-area GDP had grown by a higher-than-expected rate of 0.7% in 2022 Q2. This could in part have reflected tourism returning to pre-Covid-19 (Covid) levels as restrictions were eased. Since the May Monetary Policy Report, the euro-area unemployment rate had fallen further below pre-Covid levels, reaching 6.6% in June, while vacancies had continued to grow. However, forward-looking indicators, such as the S&P Global PMI composite output index and other business and consumer confidence survey balances had fallen sharply, indicating weaker GDP growth in Q3.

4: According to the advance estimate, US GDP had fallen by 0.2% in 2022 Q2, the second consecutive quarter of negative growth. While the fall had been mainly accounted for by lower stockbuilding, domestic final demand growth had also slowed. The unemployment rate had remained at 3.6%, while there were early signs of a levelling out of the increase in vacancies in high-frequency data. The US ISM manufacturing and non-manufacturing PMIs had both fallen in June to their lowest readings since mid-2020, although they had remained above 50, indicating GDP growth could remain weak, but positive, in Q3.

5: China’s GDP had fallen by 2.6% in 2022 Q2, significantly weaker than had been expected and related largely to the strict regional lockdowns due to Covid and continued weakness in the property sector. GDP growth in Q3 was expected to recover, due to the easing of Covid restrictions.

6: European spot and futures gas prices had roughly doubled since the MPC’s previous meeting in mid-June, as the risks of Russia limiting severely the flow of gas to Europe had started to crystallise. The Dutch Title Transfer Facility spot price, a measure of European wholesale gas prices, had risen to around €200 per MWh, close to its peak around the start of the Russia-Ukraine war. In response to Russia’s restriction of gas flows, EU member countries had agreed to a voluntary 15% reduction in gas consumption until the spring of 2023. Prices of other commodities, such as food, oil, and metals, had fallen materially since the MPC’s previous meeting, with the movements in the latter two prices likely to have reflected a weakening near-term global growth outlook.

7: Indicators of global supply constraints had remained elevated, although there were some early signs that supply bottlenecks had started to ease. Some indicators of shipping costs had declined from their peaks, while PMI surveys indicated that manufacturing delivery times had fallen back across different regions.

8: High energy and other commodity prices, global supply bottlenecks and strong labour markets had contributed to increases in global inflation rates. Euro-area annual headline and core HICP inflation in July had increased to 8.9% and 4.0% respectively. In the United States, annual headline and core PCE inflation had increased to 6.8% and 4.8% in June respectively, and annual US CPI inflation had increased to 9.1% in June.

Monetary and financial conditions

9: Since the MPC’s previous meeting, financial markets had continued to be volatile. Market participants now expected that central banks in major advanced economies would react more forcefully to near-term inflationary pressures, but could need to respond to weaker activity thereafter. Ten-year government bond yields had fallen by around 70, 80 and 90 basis points in the United Kingdom, United States and Germany respectively since the MPC’s June meeting, more than reversing the increases seen between the May and June meetings. Risky asset prices had recovered, following large declines in equity prices and increases in corporate bond spreads between the MPC’s May and June meetings.

10: A significant number of central banks globally had increased their policy rates over the past six weeks, including more than three quarters of the central banks for which the Bank for International Settlements published data. At its July meeting, the Federal Open Market Committee had increased the target range for the federal funds rate by 75 basis points, to 2¼ to 2½%. At its July meeting, the ECB Governing Council had raised its key policy interest rates by 50 basis points and had approved a Transmission Protection Instrument, to ensure that the monetary policy stance was transmitted smoothly across all euro-area countries as the Governing Council continued to normalise monetary policy. The near-term path for market-implied policy rates in both the United States and euro area implied a sharp pickup in rates in 2022, but thereafter flat-lined or fell back a little, at levels lower than at the time of the MPC’s previous meeting.

11: In the United Kingdom, market pricing was broadly consistent with an increase in Bank Rate of 50 basis points at this MPC meeting. Following the Governor’s announcement in his Mansion House speech on 19 July that the MPC would publish more details on its strategy for beginning to sell the gilts held in the Asset Purchase Facility alongside the August Monetary Policy Report, a majority of market participants now expected that such sales would begin shortly after the MPC’s September meeting. Expectations for the extent of these sales were little changed, according to respondents to the Bank’s latest Market Participants Survey (MaPS).

12: Further out, market-implied expectations for the path of Bank Rate had fallen since the MPC’s previous meeting, now peaking at just under 3% in March 2023. This path continued to be higher than the expectations for Bank Rate of respondents to the latest MaPS, although the gap between the two paths had narrowed slightly, as the median respondent to MaPS now expected Bank Rate to peak at 2.5%, compared to 2% at the time of the MPC’s previous meeting.

13: Medium-term inflation compensation measures were lower across advanced economies, including the United Kingdom, than at the time of the May Report. That might have reflected concerns about the weaker global growth outlook, lower prices for some commodities, and tighter monetary policy in the near term. Medium-term UK inflation compensation measures had remained above their average levels of the past decade.

14: Based on the 15-working day average to 26 July on which the August Report had been conditioned, the sterling effective exchange rate was around 3% lower than the corresponding level at the time of the May Report. The depreciation of sterling against the US dollar had accounted for around 60% of this fall. Sterling had appreciated somewhat in the run-up to this MPC meeting.

15: Lending rates for new fixed-rate mortgages in the United Kingdom had continued to increase materially, reflecting a further response to the increases in risk-free market rates that had been observed since autumn 2021. The pass-through of these increases in risk-free rates to mortgage rates had been close to the full pass-through that had typically been seen prior to the global financial crisis, when interest rates had been further away from their lower bound. The latest Credit Conditions Survey suggested that secured credit availability for households had declined in the second quarter, with lenders reporting that this had largely reflected a worsening economic outlook. Respondents had expected secured credit availability to decrease slightly further in 2022 Q3. As usual, increases in interest rates on unsecured household borrowing and sight deposit rates had been smaller than for mortgage lending.

Demand and output

16: Monthly GDP was estimated to have increased by 0.5% in May, following a 0.2% decline in April. The May outturn had been weaker than Bank staff had expected, but there was still uncertainty around the scale of the upward impact on activity from the additional trading day in May associated with the timing of the Platinum Jubilee bank holiday period.

17: Following a 0.8% quarterly increase in GDP in 2022 Q1, Bank staff now expected GDP to have fallen by 0.2% in Q2 as a whole, weaker than the 0.1% growth expected in the May Monetary Policy Report. Headline growth had been depressed by the run-down of NHS Test and Trace activity and by the impact of the Platinum Jubilee over the quarter as a whole. Bank staff had estimated that GDP growth excluding those factors was likely to have been around ½%, compared to around 1% in previous quarters. That was also slightly weaker than had been expected in the May Report, but broadly consistent with indicators of output growth from business surveys that had declined over the quarter. The slowdown in underlying growth was in part likely to be a reflection of the fall in real incomes due to higher global energy and tradable goods prices.

18: Most business survey indicators had weakened further in July. For example, the S&P Global/CIPS PMI composite output index had fallen from 53.7 in June to 52.1, below its long-run average but remaining consistent with positive GDP growth. Within the aggregate, there had been particular weakness in manufacturing output. The composite future output index had risen slightly in July, however. According to the Bank’s Agents, activity had grown at a moderate pace recently, with output constrained by ongoing shortages of labour and goods, and with companies reported to be more optimistic than households about the economic outlook.

19: Overall, Bank staff now expected GDP to increase by 0.4% in 2022 Q3, slightly weaker than had been incorporated in the May Report. With headline growth likely to be boosted by the unwind of the effect of the Platinum Jubilee, underlying growth was expected to slow further but to remain positive.

20: Following 0.5% growth in 2022 Q1, household consumption growth was expected to have slowed in Q2, with a further slowdown anticipated in Q3 to around 0.1% growth. Retail sales volumes had fallen by 0.1% in June, with particular weakness in clothing and footwear, and household goods stores. This had continued the downward trend in retail spending observed since the second half of 2021. According to the Bank’s Agents, there had been signs of consumer demand softening, as the fall in household real incomes was depressing spending. Food retailers had reported declines in sales volumes to the Agents, and there had also been widespread reports of a slowdown in sales of durable goods, which could be consistent with a change in the composition of spending. According to ONS data, output had surpassed its pre-pandemic level in some consumer-facing service sectors, such as hotels and restaurants, and land transport, but it was unclear whether the output of these sectors would rise much further in the near term. GfK consumer confidence had remained unchanged in July at the record-low level recorded in June. There had been some early indications of a slowing in housing demand in the June RICS survey.

21: Business investment had fallen by 0.6% in 2022 Q1 and had been persistently lower than expected in previous Monetary Policy Report projections. Relative to its pre-pandemic level, that weakness had been particularly apparent in investment in transport equipment and buildings and structures. Official data for business investment had been subject to significant revision in the past. According to the Bank’s Agents, investment intentions had softened slightly recently but had remained positive. Current investment spending had continued to be held back by cost pressures and shortages, and a greater number of the Agents’ contacts had indicated that uncertainty about demand might curtail investment in future.

22: Following changes in measurement associated with the United Kingdom’s withdrawal from the European Union, it remained very difficult to interpret recent external trade data, including being able to make consistent comparisons in these series across time.

Supply, costs and prices

23: The Labour Force Survey (LFS) unemployment rate had been 3.8% in the three months to May, equal to its pre-pandemic trough and consistent with a tight labour market. LFS employment growth had been strong, picking up to 0.9% in the three months to May. The corollary of stable unemployment and strong employment growth had been a further decline in the inactivity rate. Nevertheless, the employment rate had remained somewhat below its level immediately prior to the pandemic, with the inactivity rate still somewhat higher than it had been during that earlier period.

24: Indicators of labour demand had remained strong, alongside evidence of continued recruitment difficulties. The stock of vacancies had been relatively stable in recent months, remaining close to its record high in the three months to June. The vacancy-to-unemployment ratio, a measure of labour market tightness, had also remained elevated and, on an industry basis, this ratio for each sector of the economy had been higher than its corresponding pre-pandemic level. The Bank’s Agents’ survey on employment and pay, conducted over the six weeks to early July, had reported strong employment intentions among businesses, although respondents had expected recruitment difficulties to limit these intentions being realised. Indeed, the Agents’ contacts had reported continued broad-based recruitment difficulties, with attrition and vacancy rates higher than normal for many businesses.

25: Indicators of nominal pay growth had remained strong, consistent with the effects of continued labour market tightness and higher CPI inflation outturns. Annual growth in private sector regular Average Weekly Earnings (AWE) had been 5% in the three months to May, broadly in line with expectations at the time of the May Monetary Policy Report. Adjusted for the mechanical effects of the changes in workforce composition and the Coronavirus Job Retention Scheme, Bank staff estimated that underlying nominal private sector regular pay growth had been around 4½% in the three months to May, in excess of pre-pandemic rates of around 3 to 3½%. The HMRC PAYE measure of the median of pay growth had been around 5% in June, also above its pre-pandemic rate.

26: The Agents’ employment and pay survey had reported an increase in recent wage settlements relative to estimates from the broadly equivalent survey conducted at the start of 2022. This survey had also suggested that businesses expected to increase pay deals by around 6% over the next twelve months, which was a little higher than in the previous survey. A significant minority of respondents in the latest survey had not provided an expected pay settlement figure for the next twelve months, with some indicating that they preferred to wait to observe future CPI outturns before deciding. Given the expected path of CPI inflation in the coming months, this suggested a potential upside risk to pay growth in the near term. Around a quarter of respondents to the latest survey had given or were considering awarding one-off payments to compensate staff. Underlying private sector regular AWE pay growth was expected to pick up further, to around 6% over the second half of 2022, driven by persistent tightness in the labour market and by higher inflation.

27: The Government had recently announced pay awards for a broad set of public sector employees of around 4%, on average, which compared to an annual rate of public sector AWE regular pay growth of 1.8% in the three months to May.

28: Twelve-month CPI inflation had risen to 9.4% in June, 0.3 percentage points above the May Report projection. In contrast, core CPI inflation, excluding food, beverages and tobacco and energy, had fallen to 5.8%, around ½ percentage point below the expectation at the time of the May Report. Relative to the May Report, there had been upside news in fuel, food and, to a lesser extent, services prices. The softening in core CPI inflation had been accounted for by a deceleration in core goods prices, in large part reflecting outright falls in used car prices. Services inflation, which was more closely associated with domestically generated inflation, had risen further, to 5.2%.

29: CPI inflation was expected to rise to around 10% in July and remain at around this level through the rest of the third quarter, reflecting higher fuel, food and services prices.

30: In 2022 Q4, CPI inflation was expected to rise to just over 13%, about 3 percentage points higher than the expectation at the time of the May Report and more than 2 percentage points higher than at the time of the June MPC meeting. The majority of that upside news was due to higher expected household energy prices. That primarily reflected the very substantial rise in wholesale gas futures prices that had occurred since the May Report, most recently due to Russia’s restrictions of gas supplies to European markets in July and due to the risk of further curbs. Since May, sterling gas futures prices for end-2022 had nearly doubled. To a lesser extent, the upside news reflected Ofgem’s announced changes to the method for updating its price cap, which had been shared with the Bank in advance of publication. These changes included putting more weight on the most recent sharp increases in wholesale gas prices, via transitional observation windows. In the August Monetary Policy Report projections, the price cap was assumed to rise by around 75% in October, compared to around 40% in the May Report. That would increase the typical annual dual-fuel bill from just under £2,000 to around £3,500 in October. The switch to resetting the cap on a quarterly, rather than semi-annual, basis meant that the price cap would be reset again in January.

31: The direct contribution of energy to CPI inflation was projected to reach 6½ percentage points in 2022 Q4, nearly 2½ percentage points higher than in the May Report and expected to account for more than half of the overshoot of CPI inflation relative to the 2% target. The rise in energy prices was likely to have additional indirect effects on CPI inflation by increasing firms’ costs, which were then likely to be passed on to a wide range of prices for non-energy goods and services. Bank staff estimated that these indirect effects would contribute around 1 percentage point to CPI inflation in 2022 Q4 and, assuming gas prices followed the Monetary Policy Report conditioning assumption, would continue to add significantly to inflation during the following year.

32: Core CPI inflation was also expected to pick up again in the near term, reaching around 6¼% by the end of the year, largely reflecting strengthening services price inflation. Indicators of costs and prices more broadly had remained elevated, although recent developments had been mixed. The S&P Global/CIPS PMI composite input and output indicators had fallen back somewhat in July from their recent highs. The inflation rates of the ONS’s measures of both producer output prices and services producer prices had risen further, to historically elevated levels. The Agents’ contacts had reported that input price inflation had remained elevated and that many companies expected to pass higher costs into prices to protect their margins, which remained below normal.

33: Short-term measures of inflation expectations across households, businesses and financial markets had remained substantially elevated relative to their historical averages. Respondents to the Decision Maker Panel had increased their expectations for their own price increases over the next twelve months to 6.6% on average in July, from 6.3% in June. The 2022 Q2 Deloitte CFO Survey had reported a median expectation for CPI inflation of 3.4% in two years’ time. Two-year ahead expectations reported in the CBI Distributive Trades Survey had remained above its historical average in 2022 Q2. The Citi/YouGov measure of households’ expectations at the one-year horizon had edged down in July but had remained at historically elevated levels. Households’ short-term inflation expectations tended to move more in line with measured inflation rates than equivalent indicators of medium-term inflation expectations.

34: Most medium to longer-term measures of inflation expectations had remained above their historical averages, albeit to a less extent than their short-term counterparts. Financial market indicators of medium-term inflation expectations had fallen from their recent highs to a level that was still above historical averages. The Citi/YouGov indicator of households’ expectations at the five to ten-year horizon had eased by 0.2 percentage points to 3.8% in July but had remained at a historically elevated level. The Bank’s Survey of Economic Forecasters, published in the August Report, had a median expectation for CPI inflation of 2% at the three-year horizon. The Committee would continue to monitor measures of inflation expectations very closely.

The immediate policy decision

35: The MPC sets monetary policy to meet the 2% inflation target, and in a way that helps to sustain growth and employment.

36: Inflationary pressures in the United Kingdom and the rest of Europe had intensified significantly since the May Monetary Policy Report and the MPC’s previous meeting. That largely reflected a near doubling in wholesale gas prices since May, owing to Russia’s restriction of gas supplies to Europe and the risk of further curbs. As this fed through to retail energy prices, it would exacerbate the fall in real incomes for UK households and further increase UK CPI inflation in the near term. CPI inflation was expected to rise more than forecast in the May Report, from 9.4% in June to just over 13% in 2022 Q4, and to remain at very elevated levels throughout much of 2023, before falling to the 2% target two years ahead.

37: UK GDP growth was slowing in underlying terms and to a slightly greater extent than had been expected previously. This was in part a reflection of the fall in real incomes due to higher global energy and tradable goods prices, as well as constraints on output from ongoing shortages of labour and goods. Companies had remained more optimistic about the economic outlook than households. The labour market was tight but not tightening further. The United Kingdom was now projected to enter recession from the fourth quarter of this year.

38: The Agents’ employment and pay survey had reported that businesses expected to increase pay by around 6% over the next twelve months, a little higher than in their previous survey. Indicators of consumer and producer services price inflation had risen further in the latest data, although there had been some moderation in core consumer goods inflation. Respondents to the Decision Maker Panel had increased further their expectations for their own price increases over the next twelve months. Most other measures of inflation expectations had remained elevated, particularly in the near term, although financial market indicators of medium-term inflation expectations were lower than their recent highs.

39: The risks around the MPC’s projections from both external and domestic factors were exceptionally large at present. There was a range of plausible paths for the economy, which had CPI inflation and medium-term activity significantly higher or lower than in the baseline projections in the August Monetary Policy Report. As a result, in coming to its assessment of the outlook and its implications for monetary policy, the Committee was currently putting less weight on the implications of any single set of conditioning assumptions and projections.

40: The August Report contained several projections for GDP, unemployment and inflation: a baseline conditioned on the MPC’s current convention for wholesale energy prices to remain constant beyond the six-month point; an alternative projection in which energy prices followed their downward-sloping futures curves throughout the forecast period; and a scenario which explored the implications of greater persistence in domestic price setting than in the baseline. These were all conditioned on announced Government fiscal policies, including the Cost of Living Support package announced in May. There were significant differences between these projections in the latter half of the forecast period. However, all showed very high near-term inflation, a fall in GDP over the next year and a marked decline in inflation thereafter.

41: The MPC’s remit was clear that the inflation target applied at all times, reflecting the primacy of price stability in the UK monetary policy framework. The framework recognised that there would be occasions when inflation would depart from the target as a result of shocks and disturbances. The economy had continued to be subject to a succession of very large shocks, which would inevitably lead to volatility in output. These shocks had pushed global energy and other tradable goods prices to elevated levels. Those price increases had raised UK inflation and, since the United Kingdom was a net importer of these items, would necessarily weigh on households’ real incomes. This real economic adjustment was something monetary policy was unable to prevent. These global shocks could interact with domestic factors, including the tight labour market and the pricing strategies of firms, and could lead to more persistent inflationary pressures. The role of monetary policy was to ensure that, as the adjustment in the real economy occurred, CPI inflation returned to the 2% target sustainably in the medium term. Monetary policy was also acting to ensure that longer-term inflation expectations were anchored at the 2% target.

42: The labour market remained tight, and domestic cost and price pressures were elevated. There was a risk that a longer period of externally generated price inflation would lead to more enduring domestic price and wage pressures. In view of these considerations, all members of the Committee judged that an increase in Bank Rate was warranted at this meeting.

43: Eight members of the Committee judged that a 0.5 percentage point increase in Bank Rate, to 1.75%, was warranted at this meeting. For these members, a more forceful policy action was justified. Against the backdrop of another jump in energy prices, there had been indications that inflationary pressures were becoming more persistent and broadening to more domestically driven sectors. In a tight labour market and an environment in which companies were finding it easier to pass on price increases, a higher and more protracted path for CPI inflation over the next 18 months could increase the risk that an eventual decline in external price pressures would not be sufficient to restrain expectations of above-target inflation further ahead. Some of these members also judged that spending could be stronger than was assumed in the August Report projections if, for example, the labour market proved more resilient or some households drew down their accumulated savings to a greater extent. Overall, a faster pace of policy tightening at this meeting would help to bring inflation back to the 2% target sustainably in the medium term, and to reduce the risks of a more extended and costly tightening cycle later.

44: One member preferred a 0.25 percentage point increase in Bank Rate at this meeting. For this member, Bank Rate might already have reached the level consistent with returning inflation to the 2% target in the medium term. Demand would continue its recent slowing as household incomes were squeezed further and as past Bank Rate increases took full effect. Set against that, the labour market remained tight, and underlying wages and services prices had recently accelerated. While slowing demand would lower these domestic inflationary pressures, there was uncertainty over how much and how quickly this would occur. This member also shared concerns that the high near-term rate of CPI inflation would lead to second-round effects, prolonging the period of above-target inflation. Policy could act against those effects by generating a greater degree of slack and at the risk of oversteering medium-term inflation below target. Balancing these considerations, this member agreed that a further tightening was appropriate at this meeting, but felt that a smaller increase in Bank Rate would help minimise the risks, while retaining the option to act more forcefully if required at future meetings.

45: The MPC would take the actions necessary to return inflation to the 2% target sustainably in the medium term, in line with its remit. Policy was not on a pre-set path. The Committee would, as always, consider and decide the appropriate level of Bank Rate at each meeting. The scale, pace and timing of any further changes in Bank Rate would reflect the Committee’s assessment of the economic outlook and inflationary pressures. The Committee would be particularly alert to indications of more persistent inflationary pressures, and would if necessary act forcefully in response.

46: The Chair invited the Committee to vote on the proposition that:

  • Bank Rate should be increased by 0.5 percentage points, to 1.75%.

47: Eight members (Andrew Bailey, Ben Broadbent, Jon Cunliffe, Jonathan Haskel, Catherine L Mann, Huw Pill, Dave Ramsden and Michael Saunders) voted in favour of the proposition. One member (Silvana Tenreyro) voted against the proposition, preferring to increase Bank Rate by 0.25 percentage points, to 1.5%.

The MPC’s strategy for UK government bond sales

48: As set out in the minutes of its May 2022 meeting, the Committee had asked Bank staff to work on a strategy for selling UK government bonds (gilts) held in the Asset Purchase Facility (APF) and had committed to providing an update at its August meeting. This would allow the Committee to make a decision at a subsequent meeting on whether the Bank of England should commence gilt sales.

49: The process of reducing the size of the APF had begun in February 2022, when the Committee had voted to cease gilt reinvestments and to initiate sales of sterling non-financial investment-grade corporate bonds.

50: In line with previous communications on APF reduction, the Committee’s strategy for asset sales would be guided by a set of key principles. First, the Committee had a preference to use Bank Rate as its active policy tool when adjusting the stance of monetary policy. Second, sales would be conducted so as not to disrupt the functioning of financial markets. Third, to help achieve that, sales would be conducted in a relatively gradual and predictable manner over a period of time.

51: In the run-up to this MPC meeting, Bank staff had set out a framework for assessing whether conditions were appropriate for the Bank of England to start gilt sales, consistent with these key principles. Using this framework, Bank staff had briefed the MPC on the current state of economic and market conditions, including whether these would be consistent with sales being conducted without disrupting the functioning of financial markets. The Financial Policy Committee (FPC) had also been briefed.

52: Based on the staff’s analysis, the MPC was provisionally minded to commence gilt sales shortly after its September policy meeting, subject to economic and market conditions being judged appropriate and to a confirmatory vote at that meeting. The Committee had asked the Bank to be in a position to begin a sales programme before the end of September.

53: In the event that this should proceed, the MPC agreed to set an amount for the reduction in the stock of purchased gilts held in the APF over a twelve-month period from the point at which the policy was voted on, comprising both maturing gilts and gilt sales. The Committee judged that, over the first twelve months of a sales programme starting in September, a reduction in the stock of purchased gilts held in the APF of around £80 billion was likely to be appropriate. Given the profile of maturing gilts over this period, this would imply a sales programme of around £10 billion per quarter.

54: The planned details of the proposed programme were set out in a provisional Market Notice accompanying these minutes.

55: For following years, the MPC intended to set an amount for the reduction in the stock of purchased gilts over the subsequent twelve-month period, as part of an annual review. As such, the Committee could amend the design parameters of the sales programme as required, for example to take into account the variation in gilt maturities across those periods.

56: The MPC agreed that there would be a high bar for amending the planned reduction in the stock of purchased gilts outside a scheduled annual review. That was in order to remain consistent with the principles that Bank Rate should be the active policy tool when adjusting the stance of monetary policy, and that unwind should be predictable. If such amendments were judged necessary in order to meet its remit, for example if potential movements in Bank Rate alone were judged insufficient to meet the inflation target, or if markets were judged to be very distressed, the MPC would first consider amending or halting the sales programme before considering restarting reinvestments or additional asset purchases. The FPC would also have a role through its assessment of financial stability.

Operational considerations

57: On 3 August 2022 the total stock of assets held in the Asset Purchase Facility (APF) was £863 billion, comprising £844 billion of UK government bond purchases and £19.1 billion of sterling non-financial investment-grade corporate bond purchases.

58: Consistent with the Committee’s decision at its February 2022 meeting to begin to reduce the stock of UK government bond purchases by ceasing to reinvest maturing assets, the £5.9 billion of cash flows associated with the redemption of the September 2022 gilt held by the APF would not be reinvested.

59: Consistent with the Committee’s decision at its February 2022 meeting to begin to reduce the stock of sterling non-financial investment-grade corporate bond purchases by ceasing to reinvest maturing assets and by a programme of corporate bond sales to be completed no earlier than towards the end of 2023 that should unwind fully the stock of corporate bond purchases, the Bank would begin sales of corporate bonds in the week commencing 19 September 2022, with operational details to be published around a month ahead of auctions commencing.

60: The Committee had been briefed on operational changes to the Sterling Monetary Framework that would come into effect alongside the start of a gilt sales programme. The Bank would launch a new Short Term Repo (STR) facility to help to ensure that short-term market rates remained close to Bank Rate, and to allow the MPC to make future decisions about APF unwind independently of the implications for the supply of reserves. Alongside these minutes, the Bank was publishing an Explanatory Note setting out the broader framework for controlling short-term interest rates during the APF reduction programme, and a Market Notice describing the STR in more detail.

61: Finally, on behalf of the Committee, the Chair expressed his appreciation to Michael Saunders for his contributions to the work of the MPC since becoming a member in 2016.

62: The following members of the Committee were present:

  • Andrew Bailey, Chair
  • Ben Broadbent
  • Jon Cunliffe
  • Jonathan Haskel
  • Catherine L Mann
  • Huw Pill
  • Dave Ramsden
  • Michael Saunders
  • Silvana Tenreyro
  • Clare Lombardelli was present as the Treasury representative.

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