MNI: Spain's EU Bond Plan Runs Into Resistance - EU Sources

A plan put forward over the summer by Spanish Finance Minister Carlos Cuerpo, backing the conversion of some eurozone government debt into European Union bonds in order to boost the liquidity of the latter looks unlikely to go very far, EU sources told MNI. 

A recent meeting of senior Euro Area finance officials in Brussels expressed serious reservations towards the proposal. 

"Many member states said there are a lot of open questions, from others there was outright rejection. The impact on national issuance is a major concern especially for small member states or member states outside the euro area," said one national finance official. (See MNI: EU Safe Asset Plan Sees Positive Feedback-Spain Says) 

It is not clear if the proposal would become a "political process,” another senior EU official said.

"The technical work is ongoing. There is no political process ongoing on the matter right now. Whether or not it develops into a political process right now remains to be seen. At this point we are looking at the technical details and trying to understand what is being proposed."

MNI INTERVIEW: BOE Has Scope To Retain More Gilts- Fisher

The Bank of England's decision to retain about a quarter of the gilts in its Asset Purchase Facility is a large step in the right direction but it has room to go further and may end up doing so if the repo markets expand too far, former BOE Executive Director Markets Paul Fisher told MNI.

The BOE stated on Thursday that GBP120 billion of gilts, out of the APF’s total book value of GBP448 billion, will be retained to back banknotes, the Bank’s largest liability other than for central bank reserves. However, with GBP99 billion of banknotes in circulation, this puts an artificial upper limit on what it can hold, according to Fisher. 

"I'm very supportive of what they've done. I think it makes a lot of sense. They could go a bit further," he said. "They haven't given themselves the option of holding a non-monetary gilt portfolio on Banking Department … which they could do."

Banking Department holds all BOE assets and liabilities not tied to banknotes. According to Fisher, the concept of backing banknotes works in a formal and legal sense, but is essentially “smoke and mirrors,” as the idea that gilts are hypothecated to specific liabilities is fictitious.

"Once you do a consolidated set of accounts for the Bank of England … you've got some liabilities which are mainly reserves and banknotes, and you've just got a bunch of assets which include lending via repo to the banking system and holdings of gilts," he noted. (See MNI BOE WATCH: MPC Holds With Hawkish Twist, Slows QT)

DEMAND-LED SYSTEM

The BOE has shifted to a system under which it meets demand for central bank reserves via repos, which could involve very large amounts of gilts as collateral.

They "want to be able to expand repo in a crisis (not just QE), and it's messy, right? Because people have got to be sure they can get the cash and the systems have all got to work," said Fisher, now in academia with posts at Cambridge and Warwick universities among others.

Rather than retaining a quarter of the APF gilts, "personally, I would have just done it, say, 50-50" he said.

"They could hold more gilts. They may be right. Who knows? I just think they'll start to wince a bit if the level of reserves stays where it is, and they end up doing most of that in repo. That's going to be an eye-watering amount of repo.”

HANDING OVER TO DMO

The BOE also decided to end the practice of the MPC setting a gilt reduction target for the next 12 months each September, instead announcing a slower multi-year target. In addition, it opened the door to selling gilts direct to the government, so that the Debt Management Office can then dispose of them as appropriate. All of this makes sense, from Fisher's perspective.

Gilt market management is becoming trickier as digital gilts are coming ever more into the market, he noted. (See MNI INTERVIEW: BOE Very Near Stable Reserve Level - Fisher)

"You're also trying to navigate this shift away from pension funds buying long-dated gilts to buying more medium-dated gilts. Plus, the move to repo shortens the maturity a bit, " he said. 

Now that the Bank is down to a settled level of reserves it is better just to have the DMO doing the selling, Fisher said. "It's very easy to trip the market up with two sellers."

As there are no first or even second order monetary policy implications from the BOE’s changes, the MPC can "focus on the interest rate" rather than gilt holdings, and work on the basis that "they (the MPC) don't need to worry about that, unless there is another shock in which case they will step in to change things."

The BOE's raft of announcements alongside its September monetary policy decision helped drive down longer date gilt yields, with 30-year yields falling over 10 basis points. 

MNI BOJ WATCH: Ueda Signals More Hikes, But Timing Unclear

Bank of Japan Governor Kazuo Ueda signalled more rate hikes ahead but refrained from giving explicit hints as to their timing and pace after two Board members dissented against the BOJ’s 25-basis-point increase on Friday.

“I don’t have any specific timing,” Ueda told reporters following the BOJ’s first hike since June, which took the policy rate to 1.25%, its highest since 1995. “We will firmly discuss (policy) at every meeting,” Ueda added.

The rate hike was decided by a seven-to-two vote, with dovish board members Toichiro Asada and Ayano Sato, both nominated by Prime Minister Sanae Takaichi, dissenting.

The split vote triggered yen selling, but Ueda said that it was natural for board members to differ with regard to policy decisions.

“If all board members’ view were the same, [we] wouldn’t need to discuss [policy],” the governor said.

Two hawkish board members are set to conclude their terms in July 2027, when Takaichi is likely to appoint more doves as their replacements, potentially limiting the prospects for further tightening beyond that date.

UNCERTAIN NEUTRAL LEVEL

Policy decisions will depend completely on inflation data, Ueda said. While, in answer to questions, he declined to rule out measures such as a 50-basis-point hike or back-to-back rate increases, he noted that the BOJ should avoid tightening policy so much that it damages economic output. (See MNI POLICY: BOJ's Ueda To Strike Balanced Tone After Sept Call)

It is difficult for the BOJ to determine the neutral level of interest rates, Ueda said, adding that the Bank can only judge whether the policy rate has entered restrictive territory by monitoring economic activity and prices

While the BOJ is entering a new phase as underlying CPI inflation approaches the 2% target at which it must be anchored, this does not necessarily mean that the Bank is likely to accelerate the pace of rate hikes, Ueda said.

“The BOJ must now pay more attention to upside risks to prices than before, as financial conditions are accommodative,” Ueda said.

The BOJ continues to carefully monitor developments in the Middle East and their effects on energy prices, AI-related demand and foreign exchange markets in order to determine their impact on underlying CPI inflation. The next round of spring wage negotiations will also be a key factor for the BOJ, Ueda said.

MNI INTERVIEW: Market's RBA View Too High - Fmr Chief Econ

The Reserve Bank of Australia is unlikely to hike its cash rate as much as current market pricing suggests, probably taking it up to about 4.85% but no more, despite the neutral rate drifting higher than the most recent estimate, the Bank’s former Chief Economist John Simon told MNI. 

Implied market pricing for a 5% cash rate by August 2027 from today’s 4.35% is likely driven by a lack of clear guidance from the Bank, he said, though he added that the Board will hike the cash rate to 4.6% when it meets on Sept 29.

“Maybe that's [the market's] best guess, but we really need to see an explanation from the Bank of what their strategy is," he said. "For a long time, their strategy was do the minimum and really stretch this out. They're stepping away from that, but the question is, how far are they stepping away?”

Hiking as far as 5% would imply a dramatic reversal from the Bank's recent approach, according to Simon.

"I would be surprised if they got there, but certainly they need to be higher, and they needed to be higher two years ago. But the market always seems to project things into the future that turn out too extreme. [5%] feels a bit overdone, and maybe I'm sufficiently optimistic that I hope it's not necessary." 

Senior Bank officials over the past two weeks have made hawkish comments, which Simon believes is driven by concern around inflation expectations drifting higher. (See MNI: RBA Comments Signal Tighter Policy Ahead - Ex Staff)

The Bank's past dovish strategy was framed within an optimistic Goldilocks scenario that required "a lot of things to go right," he added. "The stars haven't aligned as opposed to any one particular thing that has pushed them in the other direction," he continued.  

Simon also questioned the Bank's resolve to keep the cash rate elevated for the time needed to ensure inflation moved back to the 2.5% midpoint target. "I wouldn't think based on past form that they have the patience to hold it there, which means that we may well be condemned to a stop-start inflation experience," he said, noting the Bank failed to contain inflation completely during its previous hiking cycle in 2023. 

He called on Board members to offer their views more frequently to allow markets to understand their approach more clearly. "Unless they are dramatically more transparent and credible, I fear we'll just have a sequence of stop-start going into the future rather than hitting it on the head."

NEUTRAL RATE

Simon believes that the neutral level of rates has likely drifted higher driven by repeated supply shocks, and is close to 4.5%, about 50 basis points higher than the upper bounds of the Bank’s last estimate.

"In the past, neutral might be 3.5%, but the longer this has gone on, and particularly as we've moved from a savings glut to a savings drought – we've got huge capital demands around the world from governments and AI firms, and we've got a reduction in saving with lots of people retiring and suddenly starting to consume."

This drove a structural shift in the supply relative to the demand of capital in the economy, he added. "Which means that neutral rates are going up. But what that also means is that a restrictive policy rate is also higher than it was in the past, and I think that's really come home with the AI build out." 

MNI BOE WATCH: MPC Holds With Hawkish Twist, Slows QT

The Bank of England’s Monetary Policy Committee voted six-three for unchanged policy at its September meeting, as widely expected, but provided a hawkish twist with the swing voters tilting towards a near-term hike and the Bank also announced a slowing and complete overhaul of its quantitative tightening programme.

The vote to leave the policy rate steady at 3.75%, with Chief Economist Huw Pill and external members Megan Greene and Catherine Mann all again voting for a hike, contained no surprises. But a group of four swing voters, comprising Governor Andrew Bailey and his deputy governors, however, used varying wording to signal that with the geopolitical backdrop deteriorating and energy prices having risen they were open to hiking by as early as the next meeting in November.

In his policy paragraph in the minutes, Bailey said that if the Middle East conflict "persists for an extended period, as appears to be the case, and the risk of second-round effects emerging increases, it is likely that policy may have to tighten."

His three deputy governors all provided similar lines, with Sarah Breeden talking about it being "increasingly appropriate for Bank Rate to respond," Clare Lombardelli saying that "the case for building Bank Rate is building the longer the conflict continues," and Dave Ramsden citing a case for tightening.

That bloc of four, together with three votes in the bag for a hike, leaves the door wide open to a November hike.

SLOWER, REWORKED QT  

In addition, rather than announcing a fresh round of gilt sales for the next 12 months as it has previously done, the Bank switched to a multi-year approach, with a sharp slowing in the planned pace of asset sales and a decision to hold a large quantity of the gilts acquired through quantitative easing to maturity. 

The logic for a rethink of the Bank's QT strategy has been clear, as it removes the uncertainty generated by selling varying amounts of gilts each year into turbulent markets, but the Bank has moved more swiftly that expected to unveil a fully revamped approach. (See MNI INTERVIEW: BOE Very Near Stable Reserve Level - Fisher ). 

The BOE will unwind its holdings at an average GBP46 billion per year, with just GBP20 billion of active sales annually, a step change down from its approach over the previous four years, during which it had reduced its gilt stock by an average of GBP87.5 billion a year with an average of GBP32 billion of active sales.

The long end of the gilt yield curve has been very volatile and the BOE announced that GBP120 billion of its longest-dated bonds, with maturities from 2049-2071, would be held to maturity and used to back bank note issuance. Another GBP222 billion of gilts set to be redeemed earlier than 2035 will be held to maturity.

The BOE also said that instead of auctioning gilts back into the secondary market it was working to sell them at market value to the government, leaving the Debt Management Office then in charge of decisions over future sales. The BOE's own APF auctions have been suspended, with a review due by April 2027. The changes effectively take the MPC out of the QE unwind process in the years to come. (See MNI INTERVIEW: BOE MPC Shouldn't Lead QT - ex-MPC's Saunders)

MNI: Trump, Xi Likely To Agree Deals On AI, Tariffs - Advisors

China and the U.S. are likely to agree a new communications channel on AI safety and to finalise a reciprocal tariff reduction framework covering USD30 billion worth of products from both sides at the presidential summit expected next week, policy advisors in Beijing told MNI.

China is also likely to commit to boost purchases of U.S. farm and energy products, advisors said. But the main objective for President Xi Jinping in his meetings with President Donald Trump will be to keep relations stable and to avoid any new areas of disagreement with the U.S. at a time when Beijing’s relations are also strained with the European Union and Japan, one advisor said, asking for anonymity.

With both sides concerned by potential catastrophic AI risks such as its use to develop biochemical weapons, some sort of limited baseline deal on the safe use of the technology looks probable, said Zhao Yongsheng, a researcher at the University of International Business and Economics’ Research Institute for Global Value Chains, noting that this would not require a high level of strategic trust.

But, with neither country ready to restrain the pace of AI development, a deal may mainly centre on establishing a communications channel to alert each other to any emerging risks, said Wang Peng, research fellow at the Institute of State Governance at Huazhong University of Science and Technology, who also saw room for alignment in areas such as setting standards for testing the safety of models.

While the White House has announced the Sept 24 visit, the trip has yet to be formally confirmed by the Chinese side. The status of Taiwan and U.S. arms sales to the island continues to be of prime importance to China, noted Zhao.

Talks on the tariff reduction framework have entered the final stage, focusing on particular products to be included, the anonymous advisor said, adding that this should be a key deliverable for the meeting. China wants it to include mass consumer goods, while the U.S. is looking for reductions in levies on agricultural commodities, energy and chemicals, the advisor said, noting that this could be of assistance to Trump before U.S. mid-term elections.

While the “Board of Investment” touted in Trump’s visit to Beijing in May could also come up at the summit, the complexity of the subject, covering themes of market access, regulatory transparency and security, means immediate deals are unlikely, said Wang. (See MNI: China Advisors See Incremental Progress From Trump-Xi)

BUSINESS LEADERS

The Chinese delegation may include business representatives from sectors such as energy, agriculture, healthcare, low-carbon, and finance, though expectations for actual deals are limited, according to Zhao, adding that the presence of business leaders was more about optics than substance. (See MNI: China To Further Cut U.S. Treasury Holdings, Advisors Say)

Trump has recently expressed openness to Chinese automakers investing in factories in the U.S., but a full opening of the U.S. market is improbable, advisors said, with Zhao noting that Chinese firms would prefer more export access anyway, given their lower costs at home. 

Chinese Vice Premier He Lifeng and U.S. Treasury Secretary Scott Bessent are expected to meet soon to lay the groundwork for the upcoming summit, said Zhou Xiaoming, former deputy permanent representative of China’s Mission to the UN Office in Geneva.

A potential extension of the pause on 24% reciprocal tariffs, which is currently set to expire on Nov 10, is likely to be a key matter for discussion, Zhou said. The 7.5% U.S. tariff targeting Chinese overcapacity is also expected to be a focus of the talks, he said, adding that if implemented it would push the total level of alternative tariffs imposed on China during Trump's second term to the established upper limit of around 20%. 

REPEAT INVITE: Livestream MNI Connect VC with ECB's Cipollone

You are invited to listen to a Livestreamed MNI Connect Video Conference with ECB Executive Board Member, Piero Cipollone.

Details below:

• Speaker: ECB Executive Board Member,Piero Cipollone.
• Topic of discussion: ‘Money in the Digital Age: Digital Euro, Tokenisation and the Role of Central Banks’
• Date: Tuesday 6 October from 1400-15.30 London/0900-10.30 ET/15:00-16:30 CET
• This event will be run as a Zoom Webinar and is a public, on-the-record event.

To register please go to: MNI Webcast Registration