BoE looks at shifting money market operations from crisis settings

Wed Aug 20, 2014 11:38am EDT

* BoE looks at how to end crisis-era money market measures

* Officials say will keep existing framework in near-term

* BoE may return to "reserves averaging system" after review

By Andy Bruce

LONDON, Aug 20 (Reuters) - Bank of England policymakers have started to discuss how to end crisis-era measures which pegged overnight money market rates to the central bank's official interest rate, the BoE said on Wednesday.

The news of high-level discussions about reforms to the central bank's money market operations - crucial to the way it implements monetary policy - came in policy minutes which also showed that two BoE officials broke ranks to vote for higher interest rates this month.

The BoE said its existing framework, which was introduced in 2009, could continue to be used in the "near term" to implement any increases in the Bank Rate, its official interest rate.

But it said it expected to give more information about changes in the coming months. Changes would also be needed once a decision had been reached about the future of the BoE's 375 billion pounds of government bond purchases, which it bought between 2009 and 2012 with newly created money to spur the economy.

Since 2009, the BoE has paid interest on all commercial banks' reserves held at the central bank at the official base rate, currently 0.5 percent, to keep money market interest rates in line with the base rate.

Members of the BoE's rate-setting Monetary Policy Committee held an "initial discussion" about changing the so-called sterling monetary framework at their August meeting, minutes of the discussion showed on Wednesday.

A BoE spokeswoman said a review would be handled by Minouche Shafik, the new deputy governor for markets and banking.

Moyeen Islam, fixed income strategist at Barclays, said the length of time needed for the review meant that the BoE would keep paying interest on all reserves for around six to nine months into an interest rate hiking cycle.

Economists and financial markets do not expect the BoE to start raising interest rates until the start of next year.

"This is the first time the Bank to my knowledge has explicitly said they intend to maintain effectively a floor system of reserves in the early part of the rate cycle," Islam added.

Following the review, the BoE could return to its pre-2009 system of "reserves averaging", under which banks chose a monthly target for reserves held at the central bank.

If they undershot or overshot reserves, they faced penalties, giving them an incentive to instead use money markets for managing their short-term liquidity needs.

The BoE suspended reserves averaging in 2009 because the introduction of quantitative easing asset purchases meant the supply of reserves reflected more the size of the stimulus, rather than demand from banks.

Since then, banks have not been required to set targets for reserve balances.

Paul Fisher - who until recently was a member of the MPC responsible for money markets - said in 2011 that a return to reserves averaging was the most likely option.

* More details on the BoE's monetary framework can be found here: here (Editing by David Milliken and Susan Fenton)

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