Without any fanfare, the Bank of England’s latest publication of narrow money showed that the money held by banks at the central bank fell by £9bn in August. This is the same period in which the Bank created £15bn and pumped it into the economy by buying government bonds as part of its quantitative easing programme. This will be surprising for those who noted that when the Bank started QE, it said that reserves held at the central bank would rise in lockstep with its asset purchase facility. What is going on?
It appears, the Bank tells me, that commercial banks have become so awash with central bank money since QE started that they stopped bidding for the stuff in the normal weekly repurchase operations. So the Bank stopped them in August and has subsequently found that demand has also dropped off for its 3-month and longer supplies of money to the banking system.
But the Bank says this is not some quiet exit strategy from emergency operations becasue banks still have excess reserves – that is money created by the central bank which ends up in the banking system. It follows that if banks have more than enough central bank money to handle normal transactions and unexpected payments, the degree of excess reserves does not matter too much.
As long as banks are sitting on lowly remunerated cash in excess of their liquidity needs, there will be an incentive for them to lend. That is what the Bank of England cares about. In any case, the Bank would have trouble getting more of its money out of door in lending operations if commercial banks already had more than enough for day-to-day financing needs.
So while August’s fall in reserves is an interesting blip, it says nothing about the Bank’s desire for an exit from extraordinary policies, and tells us very little about whether QE is, or is not, working.