The asset purchases undertaken between March 2009 and January 2010 in the first phase of the Bank of England''s ''quantitative easing'' (QE) policy had a significant and persistent impact on UK gilt yields, according to research by Michael Joyce and Matthew Tong, published in the November 2012 issue of the Economic Journal. But their study finds that the peak gilt market response may not have occurred until the auction purchases began and the market learned about the effects of the purchases.
The authors analyse the impact of QE on the UK gilt market to draw out lessons both about the effectiveness of the policy and also to shed light on the nature of the transmission mechanism from purchases onto bond prices and bond yields – a key link in the transmission of QE to the wider economy.
Their study is the first to use disaggregated high-frequency data to look more precisely at the impact of both announcements (news) about the scale of QE purchases and the actual purchases themselves through the Bank''s procedure for asset purchases known as ''reverse auctions''.
In conditions where markets are functioning efficiently, economic news would normally be expected to be incorporated into market prices as soon as it becomes available. But, given the unprecedented nature of the QE policy and the stressed market conditions at the beginning of 2009, the effects of QE may have taken longer than normal to get reflected in prices. Indeed, the full market adjustment might have been delayed until the asset purchases were actually made.
This study''s analysis of the market reactions to individual announcements about QE suggests that the initial impact from the announcements took time to be fully priced in and that the cumulative initial impact on yields varied significantly across the term structure, with the largest impact of up to 120 basis points between the 15 and 20-year maturity.
The researchers find that yields on gilts with maturities close to or in the Bank''s purchase range experienced relatively larger falls (consistent with ''local supply effects'') and that yields also fell more for gilts with longer maturities (consistent with ''duration risk effects'').
Analysis of the Bank''s reverse auctions suggests that, ahead of each auction, there were further reductions in the yields on gilts both eligible and ineligible for purchase that averaged 2.5 basis points and 1.5 basis points respectively. These effects were sometimes quite persistent, with more persistent effects being positively associated with the degree of price dispersion of the accepted offers, an indicator of price uncertainty.
As the price dispersion of offers declined over time, the authors speculate that it may reflect learning by market participants from the auction process about the necessary fall in yields in response to QE purchases. The overall impact of the auctions on gilt yields also diminished over time as both liquidity and market functioning improved.
Overall, these results suggest that the Bank''s QE policy had a significant and persistent impact on gilt yields, once allowance is made for the countervailing effects on yields of fiscal news and improving macroeconomic prospects during the period. But the peak gilt market response may not have occurred until the auction purchases began and the market learned about the effects of the purchases.
The study provides direct evidence of local supply and duration risk effects consistent with imperfect substitution. This conflicts with the textbook view of efficient markets and therefore has implications beyond the financial crisis for how to think about price determination in the gilt market.
''QE and the Gilt Market: A Disaggregated Analysis'' by Michael Joyce and Matthew Tong is published in the November 2012 issue of the Economic Journal.
This research was first presented at the Bank of England conference ''QE and other unconventional monetary policies'', held in November 2011.
The authors are at the Bank of England.
